*1. The State of the World? Not Bad  george melloan WSJFebruary 8, 2005; Page A19
2.Reality-Based Tax Policy  By Amity Shlaes   Published    08/24/2005
3. Africa Feels EU's Bite
*4. Australia Booms With Economic Freedom
5. More transparency on EU farm handouts
*6.  Arab investmentPumped up Aug 18th 2005 From The Economist print edition
 
 
 
 
 
 
 
 
 
 

1. The State of the World? Not Bad  george melloan WSJFebruary 8, 2005; Page A19

President George W. Bush gave an upbeat assessment of current conditions in the U.S. last week, saying, "the state of our union is confident and strong."

But one doesn't have to be an ardent internationalist to understand that the fortunes of Americans today are tied like never before to the state of the world. The global economy has become increasingly integrated through the free flow of trade, capital and people. Globalization, although much cursed by nativists and protectionists, is a fact of life. It has undeniably furthered that central goal of economic policy, to afford the most good for the most people.

Mr. Bush acknowledged this interdependency with his opening words congratulating the newly elected leaders of Afghanistan, the Palestinian territories, Ukraine and the "free and sovereign Iraq" for sharing with him the privilege of having been placed in office by the "votes of the people we serve." Indeed, democracy has been on a roll, with some 100 million people having voted in free and fair elections in the last four months.

That is one sign, along with vigorous growth in the global economy, that the state of the world is rather good as we enter 2005. Of course, there are the usual hellholes, such as Darfur and North Korea, but there have been few times in history when the outlook was more promising than right now. Terrorism and the war on terror notwithstanding, the amount of armed conflict around the globe is no greater than usual and there are no big wars under way.

The peoples of the world are part of what a physicist might call a "complex system." The system's many correlations and co-dependencies are so numerous as to be beyond description except in very general terms. It is not only complex but dynamic, constantly in motion and constantly changing. It is an amalgam of trillions of decisions as nearly 6.4 billion individuals seek to earn their livings, striving for a better life and more power over their human and physical environments.

Almost all are subject to the ministrations of governments of widely varying capabilities and policies. That is reflected in the great disparities in wealth and production. The 30 rich countries that make up the Organization for Economic Cooperation and Development (OECD) account for about 60% of the global economy on a purchasing-power parity basis. The International Monetary Fund estimated last September that the people of this planet would produce an estimated $40 trillion in goods and services in 2004 (gross production measured in local currencies), racking up a phenomenal annual growth rate of 5%.

Because of the disparities in the quality of governance among the 191 United Nations member states that essentially make up the political map of the globe, it can't be said that everyone is sharing in the global boom. How an individual life transpires depends on whether one is lucky enough to live in a well-led state or unlucky to be in one that is badly led. So when we ask about the state of the world, we have to ask about how much leadership wisdom is in play.

On the whole, and judged by historical standards, the answer is heartening. In this year 2005, the world's population is enjoying ever- increasing political and economic freedom as measured respectively by the Freedom House and Wall Street Journal/Heritage indices. As has been demonstrated in recent weeks in Ukraine and Iraq, people governed by benighted rulers are not eternally doomed. The emergence into the light of those peoples has cheered hearts everywhere by raising the prospect of new entrants into that part of the global community that is peaceful and productive. Greater freedom opens up new opportunities for creativity and innovation and richer lives.

Pessimists are with us always, but the spreading of apocalyptic visions seems to be entering a down market as history has proved more and more of the Jeremiahs of the past wrong. In the 1960s, there was the fear of a "population explosion" which would send the world into a period of Malthusian starvation. Population growth has actually slowed and the two most populous countries, China and India, are feeding their 2.35 billion people with no problem. India has even become a grain exporter.

A current worry is that another resource, energy, is being used up too fast. A new book, "The Bottomless Well," by Peter W. Huber and Mark P. Mills (Basic Books) explodes that myth, citing the changing ways energy is being generated and used, and promising abundant supplies for millennia.

But what about global warming? For a summary treatment of that U.N.-created hoax, turn to novelist-M.D. Michael Crichton's remarkable new bestseller, "State of Fear" (HarperCollins). It is a combination thriller and scientific treatise debunking the glib assertions by people who define themselves as "environmentalists" that the world faces a climate-change catastrophe. The incredible thing is that many nations have signed on to the U.N.'s Kyoto Protocol, pledging to spend a lot of public money to avoid this imagined disaster.
 

A character in Mr. Crichton's book, perhaps speaking for the author, theorizes that with the passing of that very real danger, U.S.-Soviet mutually assured destruction, the world's political actors -- which would include the press and not a few academics, along with politicians -- have had to invent new threats to gain public attention and influence change. Mr. Crichton warns against theories about the future behavior of complex systems, of which the climatological forces that swirl about the planet are among the most intricate and unpredictable.

Of course, there are real threats, such as nuclear weapons in the irresponsible hands of Muslim fanatics in Tehran or the murderous ruling clan in Pyongyang. But those are specific and definable, and subject to control if it becomes necessary.

All things considered, that highly complex system comprised of the world's people and the nation-states that govern or misgovern them is spinning along pretty well. In economic terms it is growing even faster than the U.S. itself, partly indeed because its largest component, the U.S., is, as the president says, "confident and strong." Perhaps that attitude is contagious.
 
 
 
 
 

2.Reality-Based Tax Policy  By Amity Shlaes   Published    08/24/2005
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http://www.techcentralstation.com/082405F.html
Better than expected. That is the headline being given to the progress of the US economy. Last year the deficit was a humiliating 3.6 per cent of gross domestic product. The deficit this year, new numbers suggest, will be 2.7 per cent of GDP -- acceptable. The difference? Extra revenues. It seems federal revenues for this year will be $85 billion higher than anyone was predicting as recently as March. Growth, too, may be stronger than expected, remaining above 3 per cent. Unemployment? Some forecasters now believe it will dive deep into the mid-4 per cent range.
These data are all impressive but perhaps most impressive are the inflows. The extra dollars are far too few to match the challenge of Washington's long-term obligations -- programes such as Social Security and Medicare. But they just about offset the $6 billion a month the US spends in Iraq. We are on our way to having guns and butter, after all.

Yet few are asking what caused the cash flow. To read the papers, you would think that the fact that the Treasury is now swimming in revenue is like a cool August day at the shore after a number of hot ones: just another pleasant surprise.

But there should be no surprise. For the inflows are the direct result of the Bush administration's commitment to a concept: individuals respond to incentives. Not merely targeted ones -- a break, say, for a specific group of manufacturers -- but overall incentives for enterprise. The administration deduced from this concept that cuts in taxes on capital and work would inspire citizens and businesses to transact more. The Bush team then proceeded to make those cuts amid jeers about incurring deficits.

Three decades ago, mainstream economists laughed off similar programes as the error of a marginal group, the supply-siders. If we want to be charitable we may say that the mainstreamers' contempt was understandable. The dominant philosophy of the period, Keynesianism, emphasized government spending as the best tool for growth. What is more, most adults in the US, France, Germany and Britain had more experience with increasing tax rates than with cutting them. Since that time, however, the US and other countries have conducted successful experiments with tax cuts. Yet the tax theory and even the underlying principle of incentives are still too often treated as strange or untested in continental Europe, Britain, or even the US. Recently, Steve Levitt, an economist publishing a book largely about incentives, felt the need to give it a self-deprecating title: "Freakonomics." Perhaps, therefore, it is worthwhile to review the record.

The Bush White House and Congress flattened the steep stair-step progressive rate structure of the income tax, lowering the top marginal rate. They cut the tax on dividends to 15 per cent from 39.6 per cent; 15 per cent became the new (lower) top rate for capital gains. They likewise created a one-time amnesty program for companies repatriating profits. Corporate tax revenues this year increased 42 per cent upon the year before. No one can be certain yet which change meant most to business; the full analysis of returns takes two years. But as Stephen Entin of Washington's Institute for Research on the Economics of Taxation notes, we know that the new money relates to non-wage income -- profits of small businesses, dividends, capital gains. Taxable income increased the most where tax cuts were most dramatic.

Earlier, President Bill Clinton and Robert Rubin, his Treasury secretary, also cut the capital gains tax. The business activity and extra revenues helped create the surprise of that era, a federal budget surplus. Yet earlier, in 1978 and 1981, the US slashed its capital gains rate twice, moving from 35 per cent (or sometimes higher) to 20 per cent. With each cut, the inflows jumped, and "the magnitude of the response clearly shocked some of the staff" recalls Mr. Entin, then at the Treasury. What those involved would recall forever was a wistful feeling -- a new awareness of the likelihood of economic growth forgone in the 1970s, the period of higher rates.

 Other nations have had similar experiences, including both the rush of success and the wistful retrospection. Britain and Ireland saw relative growth and tax revenues increase following rate cuts. Russia saw revenues increase after implementing its flat tax, and not all of it came from oil price increases. Romania, Estonia, Hong Kong -- all have seen compelling growth under flat tax regimes. Flat-tax advocate Steve Forbes has totted up the evidence in a new book. Having observed the trend among eastern neighbors, Angela Merkel of Germany's Christian Democratic Union last week named a tax cutter, Paul Kirchhof, to her campaign team.
Growth and revenues after tax cuts are no fluke. They are not freaky or ancillary. Low rates are the key to the progress of a market economy. Radical tax reform deserves mainstream respect. As for flat tax regimes, it is time to acknowledge that they are not merely a limited remedy for tax havens or small or desperate nations. When large nations cut taxes, we do not have to hope for a good result. We can expect one.

Amity Shlaes is Senior Columnist with the Financial Times.
 
 
 

3. Africa Feels EU's Bite

by Richard Tren and Marian L. Tupy
http://www.cato.org/pub_display.php?pub_id=4250

Richard Tren is director of Africa Fighting Malaria, a think tank based in South Africa. He is the co-author of a recent Cato Institute study, titled, "South Africa's War against Malaria: Lessons for the Developing World." Marian L. Tupy is assistant director of the Project on Global Economic Liberty at the Cato Institute.

In recent months it has become fashionable to say that future Western aid to Africa will be a hand up, not a handout. African governments, the aid lobby claims, will be encouraged to search for innovative solutions to their problems, free of Western interference. Yet, when the Ugandan government decided to introduce DDT, an effective insecticide, to its malaria-control program, the European Union threatened to embargo Ugandan agricultural exports to the EU. The EU threats are based on junk science. If carried out, they will cause a lot of harm.

Uganda used DDT very successfully during the late 1950s and early 1960s. Some African countries -- Eritrea, Madagascar, Mozambique, Namibia and Swaziland included -- still successfully use it. In part as a result of the pressure from the environmentalist lobby, the South African government briefly discontinued the use of DDT in the late 1990s. Between 1998 and 2000, KwaZulu Natal, South Africa's most malarial province, experienced a 400 percent increase in malaria cases and the government was forced to reintroduce DDT. By 2001, malaria cases fell to their pre-1998 levels.

Encouraged by those results, the Ugandan Minister of Health, Jim Muhwezi, floated the idea of approving the use of DDT as one way of combating malaria in Uganda. He wants DDT to be used in addition to bednets and new drug treatments. If realized, Mr. Muhwezi's wish would come not a moment too soon. Despite the fact that malaria is both preventable and curable, the disease kills up to 110,000 Ugandan children every year. Based on its past performance, it is reasonable to expect that the introduction of DDT could dramatically reduce that death rate.

Unfortunately, DDT also happens to be an insecticide that most environmentalists love to hate -- and nowhere more so than in the capitals of Western Europe. DDT has been used for more than 60 years and in all that time no scientifically replicated study has been able to link the chemical to cancer in humans. Despite the bad press from environmentalists, the insecticide has an incredibly safe record of use. In any event, when used in malaria control, DDT is sprayed on the inside walls of houses in minute quantities. The chances of any trace amounts of DDT ending up on agricultural produce are tiny, and even if they did, the effects on human health would be negligible.

The EU threats are part of a broader European agenda to force African countries to comply with rules and regulations that are totally unsuitable for Africa's level of economic development. Take Pascal Lamy, who used to be the EU's chief trade negotiator and now heads the World Trade Organization. Before leaving the EU Commission, Mr. Lamy proposed to open European markets to imports from the poor countries. In exchange, those countries would have to sign on to the Kyoto Protocol on global warming, the Cartagena Protocol on genetically modified organisms, and a plethora of international labor agreements.

But European countries did not have to comply with environmental and labor regulations when they were at Africa's stage of economic development. After Europe developed and its standard of living increased, many people were able to pay a premium for commercial goods that were produced in an environmentally friendly way. Increased efficiency of production and the concomitant reduction of waste also contributed to better environmental quality. Forcing poor countries to accede to unsuitable treaties will only slow down their economic development.

It is encouraging that the United States does not share the EU's approach to combating poverty and disease in Africa. The Bush administration has not tried to force African countries to subscribe to growth-killing environmental and labor regulations. Moreover, the administration takes a different view on how malaria should be fought. President Bush's commitment of $1.2 billion to combat malaria on the African continent explicitly allows for "indoor residual spraying with approved insecticides," including DDT.
Time will show how that money will be spent. In the past, much of the money earmarked for fighting deadly diseases in Africa was embezzled by corrupt officials. In addition, U.S. aid agencies, like the European aid agencies, actively opposed DDT use in Africa. Still, the fact that DDT is back on the agenda both in the United States and Uganda is good news for the Ugandan people.

It would be a shame if misguided environmentalists in Europe were to succeed in undermining the best hope the Africans have of defeating such a deadly menace.

This article appeared in the Washington Times, August 18, 2005
 
 

4. Australia Booms With Economic Freedom

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Source: American Enterprise, The
Publication date: 2005-07-01
http://www.builderonline.com/industry-news.asp?channelid=55&articleid=150999&qu=Australia+Booms+with+Economic+Freedom

The good times keep rolling Down Under. Australia is now in its fourteenth year of uninterrupted vigorous growth, outperforming other major developed economies. Unemployment has come down to a 28- year low of 5.1 percent today from almost 11 percent in 1992, and inflation has steadfastly remained at 2 to 3 percent since the early 1990s. The stock market is at record-breaking levels.

That Australia has been growing at a little less that 4 percent per year since the early 1990s is all the more remarkable when you consider that its farm sector has suffered its worst drought in a century. Australia's major trading partners, moreover, have faced serious downturns in recent times: Japan has remained mired in recession for more than a decade; East Asia experienced a financial crisis in 1997-98; and the U.S. slowed for a few years in the wake of the dotcom crash and 9/11 attacks.

Why then has Australia been so exceptional? Thank a smart mix of free-market reforms and prudent monetary and fiscal policies. By restraining the deadening hand of the nanny state and giving more play to market forces as the most reliable generator of wealth, Australian governments have transformed the way the nation does business.

Of course, most of the credit for creating the miracle economy belongs to the innovative managers and hardworking employees. But Canberra's political leaders have helped create a culture of competition and hard work that has driven the nation to new heights. And they have done so by taking the politically brave step of pushing a reform agenda onto a skeptical electorate. From the government-interventionist mindset that delivered economic turmoil in the 1970s, Australia has moved to an era of free markets.

Since independence in 1901, Australians had come to depend on the powers of the central government to solve nearly all the nation's problems. A restrictive immigration policy kept out competition from cheap Asian labor; high import tariffs and large subsidies protected domestic profits; and a heavily regulated workplace arbitration system guaranteed a large share of the protected pie for workers.

In the early 1980s, Australia remained economically insular, weighed down by protectionism, over-regulation, and chronic inflation. The intellectual case against big government had been waged over the previous decade by a few maverick politicians and bureaucrats as well as some leading newspaper columnists and editorial pages. In the late 1970s, the free-market position was adopted by conservatives like future prime minister John Howard. But it was the traditionally socialist Labor government that ditched its old shibboleths in the mid 1980s and implemented a reform agenda. Prime ministers Bob Hawke (1983-91) and Paul Keating (1991-96) converted the nation's protectionist mentality to the idea that living standards depend on Australians' ability to compete in the global marketplace. From this idea flowed the agenda of tariff cuts, lower taxes, reduced union power, budget discipline, low inflation, financial and exchange-rate deregulation, privatization of governmentowned businesses, increasing Asian engagement, and more independent monetary policy.

Prime Minister John Howard has sustained and extended these reforms since his election in 1996. The benefits have included a surge in productivity, lower interest rates, and a wider choice of goods and services at lower prices. Australian society now offers unparalleled opportunities. Far from producing Dickensian sweatshops, as predicted by the unions, the workplace changes have produced steady and low-inflation wage growth. Trade unions have dramatically declined while the number of small business owners and shareholders are on the rise. A recent study shows that the rewards of the economic miracle have been evenly spread across poorer, middle, and richer regions.

Howard has rightly warned that "The process of economic change and economic improvement is never completed." With Australian voters having recently given his government a broad majority, the hope is that he will move further in the direction of free-markets, deregulation, and tax reduction. He could cement Australia's new prosperity, and become the antipodal offspring of his hero Ronald Reagan.
Former TAE assistant editor Tom Switzer is opinion page editor of The Australian in Sydney.

Copyright American Enterprise Institute for Public Policy Research Jul/Aug 2005
 

5. More transparency on EU farm handouts
19.08.2005 - 09:21 CET | By Honor Mahony
http://euobserver.com/?aid=19702&rk=1
A campaign for transparency about how the EU's farm subsidies are spent has spread to now three member states.

The Netherlands has become the latest country, after the UK and Denmark, where figures are being released about how the government is doling out EU money for agriculture.

According to today's International Herald Tribune, Dutch agriculture minister Cees Veerman, last year received around €190,000 for his farms in the Netherlands and France.
Figures on how much other Dutch farmers receive are to be made public by September.
The campaign for transparency has already caused some discomfort in Denmark and the UK.
Recently it was revealed that EU farm money disproportionately benefited big agri-businesses and the aristocracy in Britain, with some wealthy landowners receiving over £500,000 in 2004.

Where and how the money was spent under the Common Agricultural Policy (CAP) used to be a mystery everywhere, but Denmark set the ball rolling mid last year when it made public beneficiaries of the subsidies.
The figures showed that also in Denmark, some of the nobility were strongly benefiting from EU handouts, including Prince Joachim of Denmark.
The husband of EU farm commissioner Mariann Fischer Boel also received subsidies from Brussels.

Rich regions benefit most
Meanwhile, the Financial Times reveals that a new report on CAP increases the inequalities between rich and poor regions in the EU.The two-year study shows that despite the recent CAP reforms, rich regions in Germany, the UK, France and the Netherlands receive a higher proportion of the subsidies than regions in southern and eastern Europe.

Around 80 per cent of the subsidies go towards supporting grain, beef and dairy products, predominantly produced by northern European farmers, while less goes towards products such as olive oil and wine that are mainly grown in southern Europe, notes the paper.

Both this report and the revelations about how CAP money is distributed come at a time when the bloc is having an ideological debate about whether the EU should be spending so much on supporting farmers when the money could also be spent on promoting growth, such as for research and development.

This debate was one of the main reasons why an EU summit that was meant to decide future spending for the bloc collapsed in June.
Pushing for reform on one side were countries such as the UK and Sweden, while France, as the main recipient of CAP funds, argued that there should be no change until 2013, when a current deal runs out.
The budget question is still unresolved and is set to be discussed again properly early next year.

6.  Arab investmentPumped up Aug 18th 2005 From The Economist print edition

Saudi Arabia's stockmarket soars
LARGE and liquid aptly describes Saudi Arabia's greatest natural resource—its oil reserves. But it applies equally to the kingdom's booming stockmarket. The Tadawul All-Share Index has risen by more than 70% this year. With a market capitalisation that exceeds $500 billion and an average daily turnover of more than $2 billion, it is now the biggest emerging stockmarket in the world, according to analysts at HSBC. (Their definition excludes Hong Kong, which is worth more.)

Rising oil prices are fuelling this growth, helped by low interest rates and, after September 11th, 2001, a growing desire among Arab investors to keep their money in the region. And there is more for them to invest in, as economies diversify and state-owned assets are at least partially privatised.
The Saudi market has already seen four initial public offerings this year and more are on the way, helped by new capital-market laws designed to bring more rigour to the system. Future flotations are expected to include Saudi Research and Marketing Group, a publisher whose titles include Asharq Al-Awsat, a leading Arab newspaper, and almost a dozen insurance companies.
Valuations are high. John Lomax, a strategist at HSBC, reckons that the Saudi market will trade on a 2005 price/earnings multiple of almost 35, more than double that of leading emerging markets outside the region. But there is strong underlying growth in the operations of many listed companies, says Walid Shihabi, head of research at SHUAA Capital, an investment bank in Dubai. For example, SABIC, a petrochemicals company whose partial free float (70% of the shares are owned by the Saudi government) accounts for almost 30% of the stockmarket's value, is doing well on the back of a relatively low cost base and rising global demand for its products.
A correction is likely eventually, but for now, with oil prices high, the good times continue. It is hard for outsiders to join the party, however. Less than 5% of Saudi shares are owned by other Gulf investors, who are prohibited from investing in banking and insurance stocks; foreigners from further afield cannot invest directly in the market, though they can get a look-in by putting their money into, say, Saudi mutual funds.
But at these valuations, would they want to? The problem with the Saudi market, according to Edmund O'Sullivan, editorial director of the Middle East Economic Digest, is too few investment opportunities for all this money. Many of the country's best companies are still private, family-owned concerns. For public investors, that is one deep well that cannot be tapped.
 
 
 
 
 
 
 
 
 

Destitution not dearth
Aug 18th 2005
From The Economist print edition
 

Niger's harvest last year was not so terrible. Why is the country now so hungry?

“MUCH about poverty is obvious enough,” wrote Amartya Sen, one of the world's best-known and most respected economists, in his 1982 classic, “Poverty and Famines”. “One does not need elaborate criteria, cunning measurement, or probing analysis to recognise raw poverty and to understand its antecedents.” But the thesis Mr Sen propounded in that book was not obvious at all: some of the worst famines, he argued, have taken place without any significant fall in the supply of food.

One of the examples Mr Sen chose to illustrate his thesis was a famine that gathered force from 1968 to 1973 in the Sahel region of Africa. The Sahel, from the Arabic word for “shore”, typically refers to a group of six countries on the western fringes of the Sahara, where the desert sands lap up against the vegetation of Africa's semi-arid zones. The countries worst affected by this disaster 30 years ago were Mauritania, Mali, Upper Volta (now called Burkina Faso)—and Niger.
 

Famine relief
Aug 18th 2005
Food shortages ease slightly in Niger
Aug 18th 2005

Debt and development

Economics

Food and drink

Click to buy from Amazon.com: “Poverty and Famines”, by Amartya Sen.

Nobelprize.org has more information on Mr Sen’s research. See also the UN’s Food and Agriculture Organisation and CILSS.

Economics A-Z
 

Niger is once again in the grip of a food crisis, if not a full-blown famine. The distress sales of livestock, the heavy migration and the deprivation the country suffered in the early 1970s have all revisited it again this year. How well does Mr Sen's thesis explain the country's latest encounter with mass hunger?

Much about Niger's current crisis appears obvious enough: the rains last year ended early; the locusts were rampant. Who can be surprised that the country is short of food? But Niger's harvest last November was merely mediocre, not disastrous. Although the rains ended early, the country's cereal production was only about 11% below its five-year average, according to the UN's Food and Agriculture Organisation (FAO). It was 22% greater than the harvest of 2000-01, a year that passed without alarm. The locusts did more damage to the region's fodder than to its food, prompting pastoralists and their herds to begin an early migration to greener pastures in Niger's coastal neighbours.

Purchasing powerlessness

Niger's distress shows up most clearly in prices, not quantities. A pastoralist's terms of trade depend on two prices in particular: the price of what he can sell (his livestock) and the price of what he must buy (food). In Niger this year, the latter has soared; the former has plummeted. According to one report, the price of millet and sorghum rose to 75-80% above its average for the last five years. By June, the sale of one goat bought half as much millet as it had six months earlier. It is precisely this kind of cruel twist in the terms of trade, Mr Sen argued, that can bring a community to its knees. These unfortunates will suffer a lack of power to purchase food, even if there is no lack of food to purchase. Why did prices move against Niger's pastoralists so far and so fast?

The spike in the food price may have reflected high foreign demand as much as low domestic supply. Traditionally, during the lean months before their harvest, Niger's farmers import cereals that are cheaper to grow in wetter, coastal neighbouring countries than in their own country. But according to CILSS, an intergovernmental body responsible for the region's food security, significant amounts of grain have this year been flowing in the opposite direction. Ghana, Benin, Côte d'Ivoire and Nigeria have all been buying up grain in the region.

This is partly because these countries' own harvests were disappointing. But in Nigeria's case, the FAO thinks that government policies were also to blame. Nigeria has imposed controls on imports of rice and wheat products; it has also taken steps to protect and promote its millers and poultry farmers. Both of these policies have raised demand in the country for millet and sorghum, which provide alternative sources of flour as well as chicken-feed. As a result, Nigerian cereals that might have found their way to Niger are instead being consumed at home. Nigeria has twice Niger's income per head and more than ten times its population. Its powerful market pull may have helped to undermine the purchasing power of Niger's pastoralists. “In the fight for market command over food,” Mr Sen noted in his book, “one group can suffer precisely from another group's prosperity, with the Devil taking the hindmost.”

Nigeria, with Burkina Faso and Mali, has also restricted grain exports to Niger this year, violating its trade treaties with the country. Such restrictions have often played an ignoble, supporting role in the history of famine. A ban on cereal exports between India's provinces, for example, condemned Bengal to ruinously high prices in its great famine of 1943.

What of the other term in the terms of trade? Livestock prices have fallen in the past year, partly because northern pastures were damaged and animals were emaciated as a result. But the deterioration in the terms of trade can also generate its own momentum. Higher cereals prices prompt herdsmen to sell more of their livestock. These distress sales drive the price of animals down further, forcing pastoralists to sell still more of their herd. In his book, Mr Sen raised the theoretical possibility that a pastoralist's supply curve might actually bend back on itself: as the relative price of livestock falls, a hungry pastoralist might supply more animals to the market, not fewer as elementary economic principles would imply.

If mass hunger were simply the result of there not being enough to eat, the remedy would be obvious: more food. The emergency rations now being shipped, flown and trucked into the Sahel are indeed necessary and urgent by the time hunger and destitution are acute and widespread. But if mass hunger begins with a collapse in purchasing power, rather than a shortage of food, it does not take an airlift to prevent it. What is needed is a way to restore lost purchasing power by, for example, offering employment, at a suitable wage, on public works. The market respects demand, not need. But give the needy enough pull in the market, and the market will do most of the rest.
 
 

PROSPERITY OR SLOTH?
------------------------------------------------------------------------

Economists have discovered that recipients of windfalls (bequests or
lottery winnings) often use their new wealth to purchase a delightful
commodity: leisure, says American Enterprise contributor James
Glassman.
The theory is simple: the more money you receive, the more likely
you are to exit the workforce, and if you remain, the less you will
work. This is true for countries such as France, Germany, Italy and
Japan where individuals are richer than they used to be and do not work
as hard or as long. The result has been slower growth of gross
domestic product (GDP) in these countries.
Contrast this with nations like China, Korea, Thailand and the
United States. Their less onerous and intrusive economic policies have
resulted in tremendous growth, says Glassman:
   o    Since 1990, GDP in the United States has grown at an average
        of 3.1 percent annually; in Europe the rate has
        been 2.1 percent; in Japan, 1.3 percent.
   o    As a result, GDP per capita in the United States ($38,000 in
        2003) has soared past that of other developed
        nations: $28,000 for Japan, Italy, the United Kingdom and
        Germany.
Economists are accepting that less-burdened economies produce
faster growth, but complacent nations would rather adopt policies
intended to redistribute income, avoid the effects of competition and
institutionalize long vacations, early retirement and generous
unemployment and disability payments. Quite simply, Europeans and
Japanese have decided to spend their new wealth on leisure and
stress-reduction, says Glassman.
Why haven't Americans done this? The answer lies in the culture,
says Glassman:
   o    Americans tend to be more satisfied with their working
        lives, even though they receive less vacation time.
   o    Nearly 53 percent are completely satisfied with their
        vacation time and only 17 percent are somewhat or
        completely dissatisfied.
   o    New immigrants balance out citizens with enough prosperity
        to opt for more leisure.
Source: James Glassman, "What Do You Do With Riches?" American
Enterprise, July/August 2005.
For text:
http://www.theamericanenterprise.org
For more on International Economic Growth:
http://www.ncpa.org/iss/eco/
 
 
 

Singapore and Malaysia's Different Paths

By SALIL TRIPATHI
WSJ August 8, 2005

It was 40 years ago tomorrow that Lee Kuan Yew, with tears rolling down his cheeks, told the people of Singapore they were on their own. On August 9, 1965, then Malaysian Prime Minister Tunku Abdul Rahman had bluntly informed his Singapore counterpart that the merger of the two countries had failed, and the island must fend for itself.

Four decades later, Mr. Lee and Singapore as a whole, can afford to smile at how well they have accomplished that task. Singapore is one of the most prosperous societies in the world, with one of the busiest ports, an efficient airport, and it is a preferred location for multinationals to set up shop. Singapore achieved this by accepting that nobody owed the island a living. It played the role of an efficient middleman, one the market couldn't do without.

Malaysia has also made great strides during the past 40 years, emerging from being primarily known as a rubber plantation, tin mine, and timber forest, to become a more diversified economy. But Malaysia also has some serious thinking to do about what went wrong, and to set that right, it needs to shed its stubborn nationalism.

To understand the separate trajectories of Singapore and Malaysia, look at the two "national champions" the two countries pinned their hopes on, and how they were nurtured. Singapore's best-known brand is Singapore Airlines (SIA); Malaysia's, the automobile Proton. And those choices reveal a lot about the two countries.

From the beginning, the managers of SIA were told that the airline had to perform or perish. It's true that the airline, like all national flag carriers, enjoyed the advantages that come with restrictive international air-rights agreements. But, beyond that, SIA enjoyed no special protection and had to sink or swim in a highly competitive market. Realizing its domestic market was too small, SIA focused on attracting international customers by providing better service than other airlines. It kept its fleet young (it is the world's biggest operator of Boeing 777s). Its staff, management, and crew, were drawn from around the world; its aircraft made in America. What was Singaporean about it was the way the airline was managed. SIA became the metaphor of Singapore, Inc. It also made it one of the world's most profitable airlines. Lately, hard times in the region have affected the airline, requiring layoffs and labor unrest. But in spite of that, it has remained in black. Despite rising fuel costs, its operating profit in the last quarter was S$253 million (US$153 million).

In contrast, Malaysia chose a different national champion, Proton. In building the national car, Malaysia paid little attention to international markets. Proton was a national project in a command economy. It was at least a decade late in taking advantage of the global auto boom, and the only way it could establish dominance domestically was through the stiff tariffs imposed on competitors.

Even that was not sustainable. In 1999, two-thirds of all cars sold in Malaysia were Protons; today the figure is 40%. Exports have also declined. As industries around the world, and particularly in East Asia, have shown, closing the door to competition by erecting tariff walls and insisting on local content are, in the long term, losing propositions. Realizing this, the Malaysian government recently replaced Proton's CEO, Tengku Mahaleel Ariff, partly because he opposed auto imports. Volkswagen, itself a troubled giant, may now emerge as Proton's savior.

To be sure, Singapore's success hasn't been trouble-free. It too has made bad business decisions, at home and abroad. It has also experienced domestic recessions and suffered from regional crises. But it has been able to bounce back because it has been pragmatic, with relatively flexible labor markets which allow it to respond with agility, and it has constantly sought opportunities where it could add value. This approach has given Singapore a ruthless, unemotional edge -- witness the lack of emotions when a city icon, the Raffles Hotel, was acquired by an American investment group. In many other countries there would have been emotional debates about it, something Singapore doesn't encourage. Debates are a luxury, Singapore's leaders would argue, because they delay decisions.

By emphasizing efficiency above much else, Singapore has acquired the look and feel of a corporate town, with the symmetrical dullness that comes from a city that hasn't really known chaos. Predictability may not be exciting for everyone, but for multinational companies requiring up to the minute logistical certainty, Singapore is ideal. That quality allows Singapore to respond more effectively to changing currents, to survive amidst volatility, and to remain an asset for the global economy.

In contrast, when Malaysia has faced crisis, it has often taken quixotic decisions, spurred by nationalism. Former Prime Minister Mahathir Mohammed's Look East policy was partly devised to spite the West, although it was also intended to lure Japanese investment. Mr. Mahathir's response to a political dispute with Britain was to launch a "Buy British Last" policy. In the mid-1990s, Dr. Mahathir spent vast amounts on building projects, some of which had questionable economic value: a new capital in Putra Jaya, a high-tech city called Cyberjaya, a new airport in Sepang, an offshore financial center in Labuan.

The projects were well executed, but they were built as monuments, and the underlying intent seemed to be to offer Singapore at a discount. But Cyberjaya did not take away business from Singapore's IT sector because Singapore not only allowed free import of equipment, but also liberal entry for overseas IT professionals. By comparison, it was hard for companies to recruit foreigners for projects in Cyberjaya. Similarly, Singapore built skyscrapers in the Shenton Way/Raffles Place corridor because the island's high population density and limited land demanded such construction. Petronas Towers emerged in Kuala Lumpur because Dr. Mahathir wanted the world's tallest buildings at home. And when currency speculators attacked the ringgit in 1997, Dr. Mahathir's response was to impose capital controls. He locked up the ringgit (as well as his able finance minister and deputy, Anwar Ibrahim, a formidable rival who the markets loved) and resorted to domestic solutions.

Malaysia has begun taking steps to emerge from such isolation since Abdullah Ahmad Badawi succeeded Dr. Mahathir as prime minister in October 2003. By unpegging the ringgit and initiating management changes at Proton, Malaysia appears to be retreating from the narrow nationalism of the past. As political scientist Garry Rodan, director of Asia Research Center at Perth, puts it: "The prospects of reform and of developing a stronger, independent domestic business class are better in Malaysia because of the apparent unraveling of some of state companies and the problems of crony capitalism."

Clearly, challenges exist for both countries. Maintaining and increasing prosperity will be tough for both because many things the two can do, others -- particularly China and India -- can do cheaper. The trick lies in shedding dogma and developing flexibility. In that, Singapore may seem to have an inbuilt advantage, but the demographic and political landscapes are changing. Economist Mukul Asher, professor at the Lee Kuan Yew School of public policy in Singapore, says the main test for Singapore now is how to address the challenges of an affluent and rapidly aging society requiring better balance between policies which increase competitiveness of Singapore as a business location and those that satisfy only the material needs of the population. Singapore needs to realize that markets matter, and so do people. Malaysia, for its part, needs to accept that people matter, and so do markets.

Mr. Tripathi is a London-based writer.
 

Less Live 8; More Self Help
By Tim Worstall   Published    08/04/2005
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So I guess that now the G8 have signed on for more aid to Africa, the Live8 stars are all cuddled up with their increased royalties and we are generally being more caring and sharing with the taxpayer's money, everything will be hunky dory in, ooh, any day now?

Distressingly this may not be the case. Percy Mistry of the Oxford International Group has a paper coming out in October's African Affairs.  The gist of his argument is that by concentrating on financial capital we are missing the reason that development is slow or non-existent. Rather, it is a shortage (or multiple shortages) of human, social and institutional capital that is the constraint, and throwing more money at the problem will not just be useless but will in fact make the problems worse.  The reason? Those countries fed enough aid money for the elites to survive will not need to make the radical adjustments necessary to overcome the real problems.

From his introduction:

This article argues that aid to Africa has not worked because human, social and institutional capital - not financial capital -- poses the binding constraint.  In that context, doubling aid to Africa from $23 billion in 2004 to $50 billion annually by 2015 seems questionable. The U.S. government is right to be skeptical.  More aid may help to relieve the human suffering inflicted in abundance on Africans by their governments.  But more aid has not prevented or reduced an increase in such suffering since 1965.  It has been an inadequate Band-Aid for treating a deep-rooted cancer.

Those are, as you might imagine in these, oh, so enlightened times, fighting words. While we should note that none of this is about emergency aid, the alleviation of famine or disease, it just isn't done to go round saying that the problems might in fact be inside African countries, not ones that are amenable to a simple redistribution of the world's wealth.

To take one seemingly trivial example, that of mobile phones. The Economist has highlighted recently a paper that points to a rise in 10 per 100 people using mobiles as leading to a 0.6% rise in GDP growth (that is, not 0.6% of the rate of growth, but growth in GDP of 0.6%).

That's a stunning number when you look at it first. What? Just one in 10 people being able to tell the wife they'll be late for dinner increases growth that much?

But if you think a little deeper it all becomes clear. Land lines hardly exist in these countries; there is no reliable method of communication at all other than the bush telegraph (otherwise known as people gossiping). With even such a small penetration into the market, farmers and fishermen can check the price of produce and then take theirs to whichever local market is offering the best price. Just this simple freedom from local monopolies in sales and the purchase of inputs adds greatly to the efficiency of an economy and thus to growth.

Meskel Square, a blog from Ethiopia, takes up the story:

Those lines have been a long time coming. For years there has been a huge backlog in the SIM cards distributed exclusively through Ethiopian Telecommunications Corporation (ETC), a state monopoly. Until recently, the only way to get one was to go on a two-year waiting list, rent one by the week, or get a letter from some ministry pushing you ahead of the queue. (As a registered journalist, I got to use the last technique with the help of the Ministry of Information).

The recent rush for SIM cards highlights two things. First, and most obviously, there is the huge demand for mobile phones in Ethiopia, and beyond that, Africa as a whole. The second is the inefficiency of leaving the state to run a country's telecommunications industry. There is a huge demand for mobile telecoms in Ethiopia and - in the worldwide market - there is a huge supply of mobile handsets and services. But, for some reason, over here supply is so limited that the arrival of some SIM cards starts a stampede.

He also notes the points made by The Economist:

And yet more can be done to promote the diffusion of mobile phones. Instead of messing around with telecentres and infrastructure projects of dubious merit, the best thing governments in the developing world can do is to liberalise their telecoms markets, doing away with lumbering state monopolies and encouraging competition. History shows that the earlier competition is introduced, the faster mobile phones start to spread. Consider the Democratic Republic of Congo and Ethiopia, for example. Both have average annual incomes of a mere $100 per person, but the number of phones per 100 people is two in the former (where there are six mobile networks), and 0.13 in the latter (where there is only one).

This is a clear case where supply side reforms (no, the phrase does not just mean tax cuts, it means reform of the supply of things) will benefit development. No more money is needed, nothing difficult has to be done, all governments have to do is license several competing companies to provide mobile services and then get out of the way. So much so that we could usefully state that this is a test for how serious a ruling oligarchy is about desiring development. If you don't liberalize the telecoms market, something we can clearly see will do good, with no downside at all (except for whichever Minister gets the money for putting people on the priority list), then no more money. Sorry, you're not being serious.

To return to the larger picture, Mistry highlights one very good point -- that Africa isn't actually short of money at all:

It is generally accepted that legal and illegal capital flight from Africa exceeds $50 billion a year. Some estimates go as high as $100 billion.  That far exceeds annual receipts of aid (averaging $20 billion in 2000-04) or of private investment ($9-10 billion).  The amount of capital held abroad by Africans is thought to be over $500 billion; most of it owned by Africa's political and bureaucratic elite.

Now leave aside for a moment the subject of corruption, the fact that some or most of this money is stolen. The question we really want the answer to is why is this money not invested in Africa by those who know the place? They are, after all, the people with all the power there, so it shouldn't be all that difficult for them to invest it profitably now, should it? (It's known to help profit margins if you have both all the money and all the guns.) Indeed, given the lack of financial capital that we generally think Africa suffers from, we would expect returns there to be higher than elsewhere … things in short supply tend to command high prices.

So why is it that wealthy Asians invest only 3% of their assets outside their home countries and rich Africans invest 40% or so? Why do those who know what is going on refuse to get those high returns on offer at home?

Sadly, it seems to be that those who know what is going on, those who actually rule these countries, do not actually trust the laws they themselves create and administer to make those investments pay.

The money is already available, in the pockets of Africans themselves, but isn't being invested to create further wealth at home because, well, because of a lack of human, social and institutional capital. Those things we take for granted, the rule of law, sanctity of contract, safety of private property and the like. We should, therefore, be looking, perhaps (after we have dealt with famine and disease), to aid development by concentrating on the supply side, sorting out the infrastructure of the economy, rather than simply pumping money in.

There's one aid agency that seems to have already understood this. Yes, I know the Millennium Challenge Corp. has taken a lot of stick over the speed with which it moves, but again, from The Economist (unfortunately behind the subscription barrier):

The land-tenure system in Madagascar, as in most poor countries, is a mess. Few farmers have clear title to "their" land, so they cannot easily sell it or use it as collateral to raise loans to improve their productivity. They tend to use land until it is exhausted and then cut down more of Madagascar's pristine rainforest.

The land registry has a backlog of 200,000 claims, which it processes at the rate of 1,000 a year. All records are on paper, stored in mounds on shelves. Both the office's manual typewriters have broken "R" keys -- the most common first letter of Malagasy surnames. The MCC is funding an effort to modernise and computerise the system.

The agency is also backing reforms aimed at creating a proper banking system. Madagascar currently has few banks, which make most of their profits by lending to the government. They don't lend to small businesses because they don't know how to assess business plans and most small businessmen don't know how to write them. The Malagasy government has drawn up a sensible-sounding list of ways to improve both the supply of credit and the quality of demand for it. The MCC will pay for it.

The New York Times has dismissed these efforts as "worthy" but beside the point in a country where many villages lack running water, clinics or schools. Many Malagasy disagree. "These are our main bottlenecks," says Emma Ralijohn, who co-ordinated Madagascar's application to the MCC. "Other donors never tried to solve these problems," she adds.

 I realize that it may come as something of a surprise to certain commentators over there in the US, but it does seem that the Bush administration actually has the right idea about development aid. Sort out the supply side; get the infrastructure, institutional and social right first, then, who knows? Will further aid even be necessary? For if the environment is conducive to money making then all that flight capital is going to come rushing back, to the great benefit of both the general populace and the investors.

I do hope so, for much as I loved Pink Floyd's appearance at Live8 (and especially their agreement to donate their increased royalties sneered at above), I'm not sure I could cope with another such concert in another 20 years -- when I'm pensionable and they're over 80.

That would be cruel on us all, Africans, musicians and listeners alike.
 
 
 

By Reason Or By Markets
By Rowan Callick   Published    08/04/2005
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Flamboyant, cravat-wearing bastion of Chilean capitalism Hernan Somerville spoke to me with enthusiasm, on a recent visit I made to Santiago, about a five-hour dinner he had enjoyed a few days earlier with socialist presidential candidate Michelle Bachelet. Bachelet's father, an air force general, was tortured to death under the 1973-90 dictatorship of General Augusto Pinochet. She fought as a guerrilla, was caught and tortured, and went into exile, including two years spent in Australia.

Bachelet, a former defense and health minister, is the favorite to succeed Socialist Ricardo Lagos as Chile's next president after the Dec. 11 election. Somerville, a leading banker and president of the Confederation of Chilean Manufacturing and Commerce, said: "The fact that Bachelet was in the trenches 30 years ago against Pinochet doesn't mean much today. When we talk, she is more interested in learning from me about how we can further open the economy and so on. The confederation has a superb relationship with the government. She may win the presidency, while the right will probably control the Congress. But no one in this country would now dare to change our basic economic course. I'm not going to have a nightmare about that. This is a most important asset."

Chile has maintained its inexorable climb into middle-class status as a settled, attractive, forward-looking society for a good reason -- its core economic policies are set, and wealth creation is at the center. Political debate revolves chiefly around education and health policies, and how welfare is administered and distributed.

Of all the Latin American economies today, Chile is probably the most successful. That success seemed precarious while it was surrounded by disaster zones. Now, however, the region is moving steadily ahead, with a general policy consensus that resembles the economic template by which East Asia has risen rapidly from poverty to become the world's chief engine for growth.

Chile's success is all the more surprising because of its violent and painful history. The state motto is "Por la razon o la fuerza": "By reason or by force." Often in the past, the latter has prevailed. But times have changed.

The emergence of businessman Sebastian Pinera, never identified with Pinochet, as potentially Bachelet's centre-right presidential election opponent, confirms Pinochet's irrelevance. Though Salvador Allende, who shot himself with a handgun given to him by Fidel Castro as Pinochet's forces bombed the presidential palace, remains venerated by many Chileans for his courage, his program of nationalization and protection no longer exists. His views are fading away, as if still locked inside his now blocked-off former office, and most of the unions which championed him have lost their clout.

Pinochet was succeeded, after 1990, by a succession of centre-left governments, led most recently by Lagos, a distinguished lawyer and economist with a doctorate from America's Duke University. He worked for the United Nations and returned in 1983, five years later electrifying TV viewers with a live denunciation of Pinochet that established him as a leading political opponent. In power, he has stressed the need to balance growth with social policies. The economy today is more open than most in the industrialized West. Privatizations have persisted under the centre-left Concertacion coalition. Half the country's 26 banks are now foreign-owned, and there are no restrictions on foreign ownership except of radio and TV.

In the 1970s, tariffs were 1000%. The average weighted tariff is now 2%, thanks substantially to Chile's role as a global champion -- together with Mexico -- of free-trade agreements. The country has completed 47, with new deals being negotiated with China, and with a group incorporating New Zealand, Singapore and Brunei. Seventy-five per cent of the economy is traded. The peso is strengthening. Interest rates are at U.S. levels, 2.5 % or so. The result has been steady economic growth, averaging 6.4% through the 1990s and 5.9% last year, including 7.3% in the final quarter. Debt is down to 11% of GDP while the government has produced a 2% budget surplus this year. And the poverty level, 50% in 1988, is about 6% today.
After this year, the president's son, Ricardo Lagos Weber, is likely to have a bigger say in such matters than Lagos, who is retiring. He is standing for Congress (and is expected to win) in December, and may move swiftly into an economic portfolio if the centre left coalition retains power. At present, Lagos Weber is the director of multilateral economic affairs at Chile's Foreign Ministry, and constantly on the move, not only because of Chile's many free-trade agreements, but because it is especially active in World Trade Organization issues, as a member of the Cairns Group of agricultural exporting nations and of the G20 group of developing countries that has emerged as a powerful influence on the Doha round.
Because so much of Chile's economy is traded, Lagos Weber said, it couldn't afford to wait for markets to open as the WTO talks dragged on, and it launched into its flurry of free-trade agreement deals. "Once you're in this process, you have to negotiate with everybody, that's the only way to avoid trade diversion. We are almost there, with deals with our main 20 partners, with only Japan yet to come. But we are only a small country, so we have to accommodate ourselves to our bigger partners, and seek further gains from the multilateral forum."

Rowan Callick is Asia-Pacific editor of The Australian Financial Review.

Even Europeans Will Respond to Incentives

By EDWARD C. PRESCOTT
WSJ August 2, 2005; Page A10

Can Europe reform? Nobel Laureate Ed Prescott thinks Europe will lower the burden of government, primarily because politicians have no choice. Spain already has lowered tax rates and liberalized labor markets, he explains, and Germany is poised to enact similar reforms. All this is true, but Prescott may be too optimistic. With a few exceptions such as Ireland, politicians in Western Europe are taking - or have taken - only modest steps in the right direction. This is akin to a strangler letting his victim take a few shallow breaths. This is better than letting the victim die, to be sure, but hardly a cause for celebration:

Medical metaphors are often used to describe an economy. We commonly hear reports of "healthy" and "strong" economies, or "sickly" and "weak" ones. In the case of Europe, with its multi-symptomatic condition, we even hear of a particular economic illness -- the European Disease. This disease is marked by high tax rates, inflexible labor markets, over-regulation and resurgent protectionism, among other maladies. Prognosis? Not so good, we are told.

However, I am optimistic about Europe. Why? To paraphrase Herbert Stein's famous maxim: The current situation is unsustainable, and what is unsustainable must end. But what, exactly, is unsustainable, and why am I optimistic that Europe's current problems will give way to a new era of growth?
* * *

Let me begin to answer that question by recollecting an event that I was privileged to attend recently in Madrid. The occasion was the awarding of the prestigious Juan Lladó Prize, sponsored by the Instituto de Empresa and the José Ortega y Gasset Foundation, given annually to work undertaken by Spanish entrepreneurs in the field of cultural patronage and research. It struck me during the course of the evening that the event -- with its celebration of entrepreneurism and its recognition of a lifetime of benefits that just one successful entrepreneur could bestow on a society -- was representative of what the future could hold for European countries.

The room was filled with entrepreneurs, both young and old, who were driven by ambition and persuaded by incentives to take the chances on which a vibrant economy is based. And it is more than passing coincidence that such an event would draw such a crowd in Madrid, because Spain's economy is one of the shining stars of the European Community, and its example gives hope to those countries still struggling under the yoke of misguided policies.

Spain offers a good case for European optimism. Like many of its continental neighbors, Spain was afflicted with declining labor force participation through the mid-1990s. Let's pause here to look at some facts. From 1993-96, the average hours worked (per working age person, per week) in Spain was 16.5. This compares with 17.5 hours in France and 19.3 in Germany. Clearly, Spain wasn't working.

Then, in 1998, Spain flattened its tax rate in a manner similar to the U.S. tax reforms of 1986. Coupled with labor market reforms of the previous year, Spain's labor force participation increased about 21% in the period 2000-2003, to 20 hours per week, exceeding that of Germany (18.3) and France (17.8). Correspondingly, this increase in labor participation led to increased tax revenues. (Incidentally, Spain, France and Germany all had slightly higher labor force participation rates than the U.S. in the early 1970s, when European tax rates were more in line with those in the U.S.)

I've made this point about tax rates before on these pages but it bears repeating because it reflects a fundamental economic insight that gets to the heart of policy making: People respond to incentives. You don't make economic policy for nations, you make it for people. And it's the responses of those people, when aggregated, that give us those data that we all love to analyze.

So, why did the European labor supply decrease by a third from the early 1970s to the mid-1990s? Because the marginal effective tax rate was increased to 60% from 40%. People chose to work less than before. Consequently, tax revenues fell. You can't raise revenues by taxing people beyond their willingness to pay. And you can't expect an economy to grow when people don't have the incentive to work, or when entrepreneurs lack the incentive to take a chance.

European countries, in other words, were approaching a point of unsustainability. Spain had reached such a point, and even though there is still progress to be made, its subsequent policy correction has worked wonders. Of course, Spain is not alone in its transformation: Britain paved the way with its earlier reforms and has since reaped the rewards from gains in labor supply, the Netherlands has also instituted important labor market reforms that have paid dividends, and some Eastern European countries are benefiting from tax reforms. It's time that the rest of Europe pay close attention to the examples of their perimeter neighbors.

Another reason for optimism is that Europe has already devised a solution to one of its thornier problems, namely, how to integrate its economies in a competitive manner that protects the property rights of other members within a country's borders. The European Union has essentially solved this problem.

With the foundation provided by its economic union, and with the examples of its newly thriving members, the groundwork is essentially laid for an economic transformation of the whole continent, including France and Germany. I am especially hopeful about Germany because, frankly, it is in worse shape and it cannot continue under the current scenario for much longer. Germany will have to act, and I expect this transformation to occur within five to 10 years. There are indications that German political leaders are moving toward more flexible labor markets; tax reform will likely follow. A shift in policy by Europe's largest economy -- with its strong leadership role -- will go a long way toward moving the whole EU toward an economic renewal.

Those European countries who are growing slower than they could or who are, indeed, losing ground, are reaching a breaking point. They cannot sustain their current path. They must, to return to our medical metaphor, take their medicine. For some, the remedy may not taste very good going down, but this short-run discomfort will quickly give way to the rejuvenated energy of its citizens and the long-run vigor of its economy. Europe has tried other prescriptions and those have failed; it's time to cure the European Disease by reviving the health of its people.

Mr. Prescott, a winner of the 2004 Nobel Prize for Economics, is senior monetary adviser at the Federal Reserve Bank of Minneapolis and professor of economics at the W.P. Carey School of Business at Arizona State University.
 
 
 

A New Vocabulary for Trade

By JAGDISH BHAGWATI
August 4, 2005; Page A12

Metaphors matter. They define how one sees reality, as when the phenomenon of skilled emigration turns into the problem of "brain drain," evoking the image of a leaky faucet that few can regard with equanimity.

The phenomenon of globalization has prompted competing metaphors. The prolific Thomas Friedman talks everywhere, and writes in his latest best seller, of globalization being marked by a "flat world." Writing almost a decade earlier in the New Republic, I advanced an alternative -- and less demotic -- metaphor, that globalization was characterized by "kaleidoscopic comparative advantage." Let me explain why the two metaphors diverge dramatically and carry startlingly different policy implications -- and why Mr. Friedman gets it wrong.

'Geography Is History'

One cannot but be aware that countries face intensified competition in the world economy -- a phenomenon that forced itself on our attention long before China and India began to loom large in fevered imaginations. Interest rates are less far apart than earlier: A continual opening and global integration of financial markets has occurred. Multinationals now consider many alternative locations for final assembly and to manufacture components, so their know-how becomes available, in effect, to several likely locations. Access to knowledge is more diffused than ever before: Student enrollments in foreign countries have grown, better educational institutions have opened in some developing countries, and the need for skilled professionals has led to shifts in immigration policies to draw them in to countries that have excess demand for their skills. Producers in distant places can now access markets thanks to the Internet, to the point where many talk melodramatically of the "death of distance," and I say, with tongue partly in cheek, that "geography is history."

Yet it is wrong to infer from this that the world has gone "flat," and that there is no comparative advantage left. The notion of a flat world is as wrong metaphorically now as it was when Copernicus showed it to be literally wrong. To be more precise than his metaphor, Mr. Friedman has on his mind not the world but a large fraction of it -- India and China. He believes that the gradient which the citizens of these countries had to climb to get to our shores and out-compete us has now disappeared, giving way to a level playing field that we ignore at our peril.

But he takes too literally his friends in Bangalore. They flex their muscles on IT the way Popeye does on spinach, and tell him that some Indians can now do anything that the Americans can do. But it is a leap to translate this into the proposition that several Indians will now do everything that the Americans do. Then again, we have Intel Chairman Craig Barrett talking about 300 million Indians and Chinese professionals who will hurtle down the flat road. And Clyde Prestowitz, in his latest book, carries the argument to its logical conclusion with the American nightmare that there will be three billion Indians and Chinese capitalists soon down that road.

In truth, the flat road is not flat at all. Take the supply of educated manpower in India. Of the numbers in the age cohort for college education, only about 6% make it to college. Of these, only two-thirds graduate, and just a small fraction can read English. Of these, a further fraction can speak it; and of these, a smaller fraction still can speak it in a way which you and I can understand. The truth of the matter, therefore, is that even for the call-answer and back-office services, the numbers who will compete are only a very small fraction of the numbers being thrown about. India's huge size and the dazzle of the few Institutes of Technology are totally misleading. The road is not flat; the gradient becomes steep as wages rise for those who can manage while others cannot qualify.

Again, just think back on why China has not managed to break into IT the way it has on a range of manufactures, while India has. Surely, that has to do with the fact that India is democratic and hence IT can flourish. By contrast, the CP (the Communist Party) is not compatible with the PC: Authoritarian regimes are fearful of IT -- a gigantic pothole in the road!

Such fears of a flat road were rampant when many thought that Japan would be a fearsome Godzilla, trampling over our activities all around. But then it turned out that the Japanese were real klutzes in the financial sector. They still are. And remember that while the Chinese and Indians have lower wages, we have better infrastructure, stronger venture capital markets, an ability to attract talent from around the world, and a culture of inventiveness. Comparative advantage persists; the road is simply not flat.

The flat road metaphor is, therefore, both inapt and mistakenly alarming. The real problem in the increasingly globalized economy is rather that most producers in traded activities -- an expanding set because services have become steadily more tradeable -- face intensified competition. A specific producer here will find rival suppliers stealing up on him from somewhere, whether Portugal, Brazil or Malaysia, indeed from sources which may not include India and China. In consequence, almost no producer is truly relaxed. I was at a Parents' Day at my daughter's camp in 1991 in Vermont and talked to a father producing chips in Silicon Valley. He lamented, as did Bill Clinton soon after, that competition from Japan and South Korea was fierce (and wicked). So I turned to another dad listening in on us and asked him what he did. "I grow mushrooms," he said. "Ah, you must be happier," I remarked. He replied, tearing at his hair: "Oh no, Taiwan is killing me!"
* * *

Gone are Adam Smith's days, when no one in Haifa lost sleep because Edinburgh could grow oranges in greenhouses: The cost differences would be substantial. Comparative advantage was "thick," shielded by big buffers. This is no longer so: not predictably from India and China, but almost certainly from somewhere. Hence I use the metaphor: "kaleidoscopic comparative advantage." Today, you have it; but in our state of knife-edge equilibrium, you may lose it tomorrow and regain it the day after. Boeing might win today, Airbus tomorrow, and then Boeing may be back in play again. It is as if the design of trade patterns that you see now gives way to another, as if a kaleidoscope had turned.

In this situation of flux and change, we see the Friedman metaphor turned on its head. Faced with fierce competition, firms and unions often seek to iron out whatever differences they can so that the cost conditions for foreign rivals are brought closer to what they are for oneself. Producer interests, including labor, lobby to narrow (if not equalize) as far as politically possible the cost advantages that accrue to rivals from differences in all sorts of domestic policies and institutions. They try, through political agitation, to shield themselves.

Hence the massive demand for "fair trade," a seductive phrase that has become a principal ally of protectionism. So you see demands for enhanced labor and environmental standards in trade treaties, not as altruism but as a way to reduce the competitiveness of rivals. This game cannot be played in the multilateral trade negotiations because countries like India and Brazil see through it. But it can be played when smaller fry are involved in bilateral Free Trade Agreements: A hegemonic power like the U.S., captured in turn by fearful lobbies seeking to flatten the world, can get the minnows to do almost anything that it wants.

The real answer cannot be to seek to flatten the world, as this flies in the face of commonsense and good economic sense as well. Except for a few universal principles, diversity of labor and environmental standards is legitimate. Forcing convergence with our standards is simply an act of high-handedness by a "selfish hegemon" pretending to be an "altruistic hegemon."

But even if plans to flatten the world thus were to succeed, they cannot but leave out the vast numbers of bumps and gradients that cannot be steamrolled: The world cannot be flattened, frankly. And so the proper response to flux is to manage it. What does this imply? Evidently, we must strengthen the Adjustment Assistance Programs, which we have done from 1962 when they were introduced at the time of the Kennedy Round of Multilateral Trade Negotiations. They must be rapidly enlarged, especially to include service workers.

A Facelift for Clint Eastwood?

But that is not enough. We also need to ensure that when a radiologist in Boston loses his work to one in Bombay, he is able to retrain for the new skilled medical jobs that arise daily as new problems arrive: e.g. the obesity epidemic and the associated diabetes outbreak. In fact, new medical employment will multiply in cosmetic surgery with an aging population as nose jobs, silicon transplants and chin tucks capture the female half and spread to the male half as well. (I have a bet that even Clint Eastwood's wrinkles will be erased some day by a facelift!) The radiologist may be able to find for himself the training to get new jobs closest to his skills; but it is clear that more aged radiologists will need more assistance, and that professional societies such as the American Medical Association could assist in this task by defining optimal transition paths from the old to the new jobs.

Yet it is not enough to say that we must educate our people to stay ahead of the curve. Yes, that is important: But it is also necessary to look at the content of the education. In a world of kaleidoscopic flux, an American aeronautical engineer at Boeing may well find that the industry has suddenly lost to Airbus, and that he must move into automobile engineering, where the Honda and Toyota transplants may be expanding. It is important that his training provide a larger share of general engineering skills and less of specialized ones. And thus, instead of succumbing to the panic of the "flat world" metaphor, we need to embrace the kaleidoscopic metaphor of flux, and redefine our institutional and policy responses to make the best use of the opportunities today in the globalized world.

Mr. Bhagwati, University Professor of Economics and Law at Columbia, and senior fellow at the Council on Foreign Relations, is the author of "In Defense of Globalization" (Oxford, 2004).
 

A New Mood in Kuala Lumpur
August 4, 2005

Prime Minister Abdullah Ahmad Badawi has been a breath of fresh air for Malaysia on a number of matters, ranging from economic policy to human rights.

We were reminded of that recently when his predecessor, Mahathir Mohamad, resurfaced to criticize the prime minister for dismantling the protectionist raj Dr. Mahathir had so carefully erected during his 22 long years at the helm. Then just yesterday, Malaysia's former police chief had to publicly apologize to a politician he had beaten up in prison in 1998 while Dr. Mahathir was in power.

One of Mr. Abdullah's most intelligent moves is his attempt to end automobile import restrictions that shielded Malaysia's state-produced car, the Proton, from competition. The Perusahaan Otomobil Nasional was the apple of Dr. Mahathir's eye, and the former prime minister remains an adviser to the company.

But Mr. Abdullah is moving boldly in a free market direction and is reportedly considering selling a stake in the automaker to Volkswagen AG. (All VW will admit to is that it does have discussions with its partners regarding Proton).

Mr. Abdullah knows that Malaysia needs to open its doors to foreign investment to contend with the rise of China. Even with prohibitive tariffs to protect it, the Proton was struggling, losing market share to imports. Market share, at near 60% in 1993, has been variously put at between 30% and 40% this year. Hyundai Motor Co. of South Korea and Nissan Motor Co. of Japan now assemble cars in Malaysia.

When Proton's chief executive officer -- who had criticized the market-opening measures -- was dropped last week, Dr. Mahathir objected, saying that the CEO was ousted not because he "had failed in his job." The stock market appeared to take a different view; shares in the carmaker shot up 8.3% the next day.

Referring to the reported deal with Volkswagen, Dr. Mahathir said, "I'm against a national car being owned by a non-national," although admitting he no longer had a say. He also challenged the government to reveal to whom it had extended import permits. Mr. Abdullah immediately disclosed the hither-to closely kept information. That a high number of these permits went to former officials was a revelation, but the disclosure at least demonstrated that the current prime minister isn't afraid of transparency.

Other differences exist. Last year Mr. Abdullah allowed a court to release the charismatic politician Anwar Ibrahim, a former deputy prime minister to Dr. Mahathir who fell out with his boss and was put in prison in 1998.

Yesterday, the police chief at the time of the arrest had to apologize to Mr. Anwar for severely beating him at one point. Dr. Mahathir was named as a co-defendant in the suit, but Mr. Anwar indicated yesterday he would drop a demand that the former prime minister also apologize.

Not everything is right with Malaysia, to be sure. Some human rights campaigners still complain from time to time. And some of the protective tariffs that were lowered have been replaced with excise taxes. But on the whole, things seem to be changing for the better.
 

Italy in Argentina's Shadow
By Desmond Lachman   Published    08/01/2005
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On looking at Italy's present economic predicament, one has to wonder whether one has not been to this movie before. Indeed, one has to wonder whether that movie might not have been called "Argentina", which was set mainly in Buenos Aires and New York between 1999 and 2001 and which had market participants on the edge of their seats till the riveting end. For while the end-game in the present Italian sequel might not be quite as sudden or as dramatic as that in Argentina, all the plot's ingredients are pointing away from a happy Hollywood-style ending.
The most striking similarity between Italy and Argentina, other than the Italian origin of many of the protagonists, is the extremely rigid currency arrangements in which the two countries managed to lock themselves. As a reaction to its harrowing mid-1980s experience with hyperinflation, in 1991 Argentina nailed its currency to the Convertibility Plan cross. It did so at the "immutable" exchange rate of one peso to the US dollar. This was supposed to usher in a period of low inflation and to force upon the country the fiscal policy discipline that it had never known before.

In a similar effort to impose macro-economic discipline, Italy has also supposedly given up forever any room for exchange rate flexibility. It did so in 1999 by abandoning the lira in favor of the euro. Gone were supposed to be the days of high inflation and periodic lira devaluations. In were supposed to be the days of fiscal discipline and structural reform that were to allow Italy to thrive inside its exchange rate straitjacket.

Like Argentina before it, by abandoning the lira, Italy has given up all macro-economic policy flexibility to stabilize its economy. No longer having its own currency, Italy cannot engage in periodic exchange rate devaluations as it did in the past to rectify losses in international competitiveness. No longer having its own central bank, Italy has to accept the interest rates set by the European Central Bank. It has done so even though the interest rates set by the ECB might not necessarily conform to Italy's particular circumstances.

As if no longer having an independent monetary and exchange rate policy were not bad enough, under Europe's Fiscal Stability Pact, Italy is committed to strengthening its public finances at a time of cyclical economic weakness. For like Argentina of the 1990s, Italy's public finances are in a real mess. With a debt to GDP ratio in excess of 105 percent, Italy is among the most indebted of the industrialized countries. With a public deficit in excess of 4 percent of GDP and rising, Italy is in clear violation of Europe's Maastricht criteria that require member countries to limit their public deficits to 3 percent of GDP.

Italy's loss of macro-economic policy instruments would not be of such great moment if its economy were booming and if its industries were competitive. All too sadly, however, this is far from the case. Already over the past two quarters, the Italian economy has sunk into recession. And under the weight of high international oil prices, this recession is only likely to deepen. Any such deepening will make it all the harder for Italy to correct its excessive fiscal imbalances.

More disturbing still is Italy's present lack of international competitiveness. Over the past five years, Italy has lost around 15 percentage points of competitiveness to Germany as wage increases in Italy were not matched by productivity gains. At the same time, Italy's failure to modernize its industries has left Italy exposed to the full winds of Chinese competition in today's increasingly globalized economy.

As was the case of Argentina before it, the only real way out for Italy is far-reaching structural reforms, especially in the labor market, that would restore Italy's competitiveness. However, one needs to ask how much more likely are such reforms in Italy under an enfeebled Berlusconi government than they were in Argentina under Carlos Menem. This would seem to be all the more so the case given the short-term pain associated with such reform.

In the absence of real reform, the most likely scenario for Italy will be a prolonged period of economic stagnation and ever widening budget deficits. This will likely force the ECB to periodically bail Italy out notwithstanding the ECB's protestations that it remains committed to its "no bail out" clause. However, in the same way that Argentina made the mistake of forever counting on IMF goodwill to paper over its economy's weaknesses, Italy will be making a grave error if it postpones painful market reforms and relies instead on the indefinite indulgence of the ECB to keep afloat its rickety public finances.

The author is Resident Fellow, American Enterprise Institute.

Corporate Social Irresponsibility
By Johnny Munkhammar   Published    07/28/2005
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Corporate Social Responsibility is a buzzword with growing implications. These days, more or less everyone is in favor of it; the standard position is "yes, of course, but how?" But the real questions are: should the state decide what, how and where companies produce and invest? Should interest-groups decide the future direction of companies?
In recent years, the CSR trend has become very strong. Political decisions and public opinion are building momentum behind the concept. Since companies are the route to prosperity, the debate is essential. And since companies are the core of capitalism - the expression of man's creativity protected by private property and freedom - it is also a discussion about principles.

A basic starting-point for a discussion of CSR could be a famous quote which states a principle for a free society and its effects:

"…every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. …He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good."

--Adam Smith, The Wealth of Nations, 1776

What has this led to? Another famous quote:

"It has accomplished wonders far surpassing Egyptian pyramids, Roman aqueducts, and Gothic cathedrals; it has conducted expeditions that put in the shade all former exoduses of nations and crusades. ...(It) draws all, even the most barbarian, nations into civilization. ... The bourgeoisie, during its rule of scarce one hundred years, has created more massive and more colossal productive forces than have all preceding generations together. Subjection of nature's forces to man, machinery, application of chemistry to industry and agriculture, steam navigation, railways, electric telegraphs, clearing of whole continents for cultivation, canalization or rivers, whole populations conjured out of the ground -- what earlier century had even a presentiment that such productive forces slumbered in the lap of social labor?"

Karl Marx and Friedrich Engels, Communist Manifesto, 1848

The point is that Adam Smith was right, and in describing reality at the time so were Marx and Engels. It is when you work to pursue your self-interest, to create a profit from producing the best goods or services -- in free competition with others -- that you actually create development and push society forward. They agreed on that, but today's CSR advocates do not.

The pursuit of self-interest creates wealth. That is what changed after thousands of years of misery and poor conditions for people. Today, the average person in the US or Europe lives better than the kings and queens of the Middle Ages. The wealth of the average Swede increased ten times between 1870 and 1970. The entrepreneurs and innovators who created the small businesses that grew to large exporting firms wanted to produce great products and make a profit. ABB, Volvo, IKEA, Ericsson, SAAB -- there are many examples. And the living standard increased; we now live decades longer, child mortality has dropped and literacy is total. Companies, focusing on their main aim, promoted the general interest.

In recent years, we have seen this phenomenon played out even more dramatically in South East Asia. Hundreds of millions of people have been brought form poverty to reasonable living standards. The reason? Companies such as Nike have gone there to promote their self-interest. They want to produce good shoes at competitive prices - and make a profit. And, without making it their explicit intention, they reduce poverty. They pay lower wages than in the US or Europe, but considerably higher than companies based in those countries do.

What does this have to do with CSR? To me, CSR is about making companies and their owners focus on other things besides their self-interest. They should not only concentrate on producing the best clothes, for example, but also on social matters. And they should not be allowed only to seek profit, if that is what they wish, since that is not "responsible".

Sometimes showing your customers that you are a "good company" can increase profits. But that is just a fraction of the CSR issue. To a large extent it is about the state trying to force companies to do things the politicians want. And to an even larger extent, it is about pressure groups trying to force companies to do what they want.

But companies should do what their owners want. If that is just profit (which you can only get by providing the best products to consumers), then so be it. Owners should not be dragged into believing that their company is no good if it does not fit someone else's definition of social responsibility.

All the goods and services, all the jobs and all the prosperity in the world, come from companies. If companies try to give more by being less focused on their self-interest, they could end up giving less. In that case all of society loses. The defense of companies and their right to pursue their self-interest is not only the defense of capitalism. It is also the defense of a society in which there is constant progress - and that includes social progress.

The author is Director of Timbro, a free-market institute in Sweden.

Cafta's False Advertising

By BERNARD K. GORDON
August 1, 2005; Page A8

The proposed Central America Free Trade Area is now close to reality. Portrayed on these pages recently as the "American Way," it was approved by the Senate in June, and the House, with less support, gave its OK last week. That may be fine for the six small nations involved -- Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras and Nicaragua -- but nobody should think it will mean anything special for U.S. trade.
The reason is quite simple: The U.S. has long been, and still is, the principal supplier to the economies that will comprise Cafta. The U.S. share is regularly at least 40% of Cafta's market, and in each of the past two years U.S. exports there were valued at more than $15 billion. Nobody else comes even close, as the chart nearby shows.

That reality, based on IMF data, mocks a prime argument and scare tactic regularly cited by pro-Cafta voices. A good example was the statement earlier this month by a former undersecretary of commerce. Tony Villamil insisted that "if we don't do this China and the European Union will step into the breach and we will lose business and influence on our doorstep."

That's utter nonsense. In 2003, China's share of the Cafta market was just 3%, up one point from 1998. The EU share, which had been 8% in 1998, also rose in 2003 by one point. Japan's share -- the bogeyman of past years and fears -- actually fell from 4% in 1998 to 3% in 2003. Meanwhile, as the chart nearby also shows, the dollar-value of America's 40-plus per cent share of the Cafta market has steadily risen to its present $15 billion.

So why do Cafta, since the U.S., as they say, already "owns" its market? The deal will add little or nothing to our overall exports, and the other countries' economies will also hardly gain. The reason is that roughly two-thirds of their exports already go to the U.S. Only Costa Rica has a lower ratio -- 25% -- while the Dominican Republic even now sends 80% of its exports to the U.S. And if the experience of Mexico's farmers with Nafta is any guide, we'll have to expect more pain among Cafta's farmers. Theirs is a tiny market, but however small, they won't be able to compete against the lower prices of U.S. farm exports.

Sure, some individual but small Cafta exporters may eventually benefit; but as we all know, one of the region's principal products -- sugar -- will gain hardly at all. That was also Australia's experience in its "Free Trade Area" deal with the U.S., when Trade Minister Mark Vaile bitterly complained both that it "failed to include sugar" and that its openings for farm goods were "the smallest and slowest of any trade pact Washington had ever written." Even so, and in the face of other irritants rooted in U.S. pharmaceutical exports, Australia signed on because, as the minister conceded, America's market of 300 million import-prone consumers was too difficult to pass up.

In the Cafta case, too, exports of American pharmaceuticals, despite expiring U.S. patents, will have an added five years of protection. That's no doubt good for American investors like my wife, who hold health-care sector funds, but as a trade and politics specialist I have to take a dim view of such special provisions. They illustrate why, as Jagdish Bhagwati has reminded us all, FTAs should in fact be referred to as PTAs: "preferential trade areas."

But there's an even greater reason to doubt, from the perspective of most Americans, the genuine need for Cafta, and that's the signal it sends elsewhere -- especially in Asia. In that region, arguments on behalf of an "East Asian Community," as well as for various Asian economic cooperation arrangements, are all the rage. They are increasingly justified as Asia's necessary response to what are portrayed as America's Western Hemisphere economic integration plans. In that light, Cafta, along with U.S. hopes to build an even broader "Free Trade Area of the Americas," are seen as poster-boys for the view that Asia must do the same.

That raises a specter first raised 20 years ago, when U.S. Secretary of State James Baker first cautioned against Asian moves that would "draw a line down the Pacific" and exclude the U.S. His warning worked then, but they've now had to be revived. In May, Richard Armitage, until recently the deputy secretary of state, called such Asian proposals "a thinly veiled way to make the point that the United States is not totally welcomed in Asia. I think that's a real mistake . . . China is quite willing to be involved in fora that don't include the United States."

We say we are pro "free trade," but we continue to undermine the WTO's genuinely global Doha Round by pressing for special blocs in this hemisphere. And we further undermine essential U.S. economic and security interests by encouraging the rise of blocs in regions that remain of profound importance to the U.S. That's something to ponder as Cafta moves closer to final approval, and in the light of clear evidence that it brings little if anything new to America's table.

Mr. Gordon, professor emeritus in economics at the University of New Hampshire, is the author of "America's Trade Follies" (Routledge, 2001).
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

India's Race to Reform

By BARUN MITRA
July 29, 2005

India's credentials as a vibrant and vigorous democracy are beyond doubt. But can democracy deliver economic development? During his recent visit to the U.S., Indian Prime Minister Manmohan Singh, pointed out that in light of the 6-7% economic growth rate over the past decade, India's experience with economic reform shows that democracy and development are compatible in poor countries. Mr. Singh acknowledged that democracy and economic reform do not always help each other. "We are often criticized for being too slow in making changes in policy," he said, "but democracy means having to build a consensus in favor of change."

Despite posturing itself as an emerging economic power, India has a long way to go. In 2003, Indian per capita income was less than 7.4% of that in the U.S. according to World Bank estimates.

The Indian economic profile, while still very small, has in recent years shown tremendous potential. The success of Indian information technology is making international headlines. But this high-tech glitz has not been able to mask underlying problems. The investment climate, though improving, is nowhere near as favorable as some competing Asian destinations. Consequently, levels of foreign direct investment have remained disappointing. Domestic economic actors continue to be hobbled by a plethora of regulations, bureaucratic and infrastructure bottlenecks. Fourteen years after economic reforms began in 1991, 30-40% of the Indian economy remains in the informal sector, which employs nearly 90% of the workforce.

This large informal economy reflects the enormous spirit of enterprise that pervades even the lowest strata of Indian society, but it also shows the reform process has a long way to go. The presence of the larger informal sector is a reflection of the continually high regulatory costs imposed on the formal sector, preventing it from providing lowest-cost services to consumers. Such artificial barriers prevent entrepreneurs in the informal sector from gaining access finance, infrastructure and marketing.

One illustration of this Indian paradox is the automobile sector. Despite over two decades of reforms, and the presence of about a dozen multinational automakers in India today, large sections of rural India continue to rely on a home made version of automobile for their daily transportation needs. This makes India the only country in the world where such homemade informal automobiles competes with the auto giants of the world.

The story is the same in the IT sector. In a country of one billion people, there are less than 20 million personal computers. And the local assemblers of PCs, many in the informal sector, outsell the branded manufacturers by at least a three-to-one margin. Only 10% of the population has access to a telephone, and only 3% has access to the internet. The foundations of Indian IT power are very weak.

The reaction to a recent report on "Economic Freedom for Indian States," edited by Bibek Debroy and Laveesh Bhandari for the Rajiv Gandhi Institute for Contemporary Studies, shows how eager India's regional politicians are to outdo one another as economic reformers. The study sought to capture the positive role the government must play in sustaining a conducive economic environment. Its authors ranked the states in three areas: size of government; legal structure and security of property rights; and regulation of credit, labor and business. The report is the first comparison of its kind of the situation in different parts of India. Constrained by availability of data, it covers only 20 of India's 35 states and territories. It ranked the western province of Gujarat at the top.

The report fired the competitive tendencies in both the Congress Party and the Bharatiya Janata Party. Congress is the major partner in the present ruling coalition government in India, and the BJP is the main opposition party in national parliament.

Narendra Modi, the chief minister of Gujarat which is ruled by the BJP, trumped the report to the local media. The fact that the report was published by an independent think tank headed by Sonia Gandhi, the leader of the Congress Party, only fuelled his zeal. In fact the report gave Gujarat barely a 40% score, and almost half the states scored under 30%. This reflects the shallowness of economic freedom despite over a decade of reforms.

The reaction to this report shows how the political climate in India has now come full circle, moving away from the past consensus around socialist ideals to a race between the two major parties to be seen as promoting economic freedom. As states within India compete to liberalize, the economic benefits of free markets might finally begin to reach even larger numbers of Indians.

Mr. Mitra is director of the Liberty Institute, an independent think tank in New Delhi.
 
 

Monday, July 25, 2005  ~ 1:17 p.m., Dan Mitchell Wrote:
New Zealand expert highlights inferiority of European social model. In a recent speech, Roger Kerr of the New Zealand Business Roundtable compares the robust performance of Anglo-American economies with the stagnant - and statist - economies of Japan and continental Europe. Kerr cites the work of Olaf Gersemann's Cowboy Capitalism: European Myths, American Realities (http://www.catostore.org/index.asp?fa=ProductDetails&pid=1441214&method
=search&t=cowboy&a=&k=&aeid=&adv=&pg=#top) to dispel myths that American success is associated with social costs:

      The big world story of the last two decades of the twentieth century was the demise of communism as an economic system and power bloc, and with it the end of the cold war between East and West. At the same time, another story has been unfolding, not as dramatic as the ending of an entire political and economic system but still of great long-term significance. That story is about the pre-eminent success of the Anglo-American economies (which include not just the United States but also Canada, Australia, New Zealand, Ireland and the United Kingdom) and the relative failure of the various versions of the so-called social market economy or managed capitalism in Continental Europe and Japan. In the last dozen years or so, economies based on free trade, private ownership, light regulation and moderate taxation have opened up what looks increasingly like a decisive lead over economies characterised by active state partnership with business and trade unions in steering the economy, high levels of taxation and social spending, a greater role for banks than for stock markets in corporate ownership and control, and intrusive regulation of business. ...I fully expect American ideas and practices to continue to exert in the twenty-first century the all-pervasive influence they did in the twentieth century and to set the standards by which all societies are judged, however much they may also be resented and subject to bogus criticism. It seems unlikely that hard-working Chinese, Indians and other Asians will be attracted to the European model.
      http://www.nzbr.org.nz/documents/speeches/speeches-2005/180705rk_cow boy_capitalism.pd

Lower tax rates, higher revenues
http://www.washtimes.com/commentary/20050723-092114-4549r.htm
By Alan Reynolds
July 24, 2005

The Congressional Budget Office reports that from October through June, "net [tax] collections from individuals were up by $105 billion, or about 18 percent.
    Almost two-thirds of that increase, or $66 billion, came from higher receipts from nonwithheld taxes, most recorded in April and May." You might think a fan of big government like New York Times columnist Paul Krugman would be delighted. But he seems to look for a cloud behind every silver lining.
    Mr. Krugman thinks "this revenue boost looks like a temporary blip," which "probably reflects mainly capital gains on stocks and real estate, together with bonuses paid in the finance and real estate industries." Even as wild guesses go, that was remarkably wild.
    A soaring stock market explains soaring tax revenues in 1997-2000, but not this year. The S&P 500 stock index in June was just 1193, barely higher than the 1131 in January 2004.
    The housing bubble is nearly as implausible, because capital gains from sale of a primary residence have been virtually tax-free since 1997. Second homes are a small fraction of the market and generally sell for much less than primary homes; they couldn't account for much of the revenue surge this year compared with last year (when home prices also soared).
    Mr. Krugman's theory that executive bonuses in finance and real estate could account for much of the $66 billion is politically correct but mathematically impossible. Top executives in the top financial firms received average bonuses of $2 million a year in 2004, according to Mercer consulting. But only the increase in such bonuses could account for increased tax collections. Even if 100 executives received an extra $300,000 apiece, that would lift the nation's taxable income by only $30 million. And a 35 percent tax on that sum would amount to only $10.5 million, which can't begin to explain a $66 billion revenue gain.
    Lacking any explanations, Mr. Krugman gets personal. "The usual suspects on the right," he writes, "are already declaring victory over the deficit, and proclaiming vindication for the Laffer Curve -- the claim that tax cuts pay for themselves because they have such a miraculous effect on the economy."
    I have not declared victory over the deficit because doing so would amount to declaring I'm content that federal spending has grown from 18.4 percent of GDP in 2000 to 20.2 percent, accounting for 69 percent of the deficit.
    Meanwhile, revenues are already back up to at least 17.4 percent of GDP -- virtually the same as the 17.6 percent figure in 1993, after President Clinton greatly increased tax rates on upper incomes, gasoline and Social Security benefits.
    As for Mr. Krugman's hasty dismissal of the Laffer Curve, he has much to learn from the new paper "Dynamic Scoring" by N. Gregory Mankiw, a recent chairman of the President's Council of Economic Advisers, and Matthew Weinzierl, also of Harvard (www.nber.org/papers/w11000). This paper uses a well-established "neoclassical growth model to examine the extent to which a tax cut pays for itself through higher economic growth." The authors explicitly "ignore any short-term effects of tax cuts that arise from traditional Keynesian channels."
    Assuming quite conservatively that tax rates on labor and capital are only 25 percent, and employing a conventional model of economic growth, Mr. Mankiw and Mr. Weinzierl find "a capital tax cut has a long-run impact on revenue of only 47 percent of its static impact. That is, growth pays for 53 percent of the static revenue loss. A labor tax cut has a long-run impact on revenue of only 83 percent of its static impact, and growth pays for 17 percent of the tax cut."
    Some economists estimate actual taxes on capital are closer to 40 percent, in which case a cut in capital taxes would lose only a fourth as much revenue as conventional budgets estimate. Some economists figure labor supply is far more responsive to tax rates than commonly assumed, in which case added growth would pay for 30 percent of a cut in labor taxes. Others stress "positive externalities" (more investment in widgets fosters related investments in gadgets and gizmos). In that case, Mr. Mankiw and Mr. Weinzierl estimate "growth pays for 74 percent of a capital tax cut and 19 percent of a labor tax cut."

As impressive as this is, there is nonetheless much more to the effect of taxation on economic growth than can be captured by a mechanical model designed in 1928.
    Research by another former CEA chairman, Glenn Hubbard of Columbia University, emphasizes the effect of marginal tax rates on entrepreneurship. Yet another former CEA chairman, Martin Feldstein, demonstrates income reported by high-income taxpayers is extremely sensitive to changes in marginal tax rates. Yet entrepreneurship and tax avoidance are not all that is missing from the Mankiw-Weinzierl calculations.
    When I borrowed the phrase "supply side fiscalism" from Herb Stein in March 1976, and suggested it to Jude Wanniski at the Wall Street Journal, we had in mind a number of incentives that have since become associated with a half-dozen Nobel laureates in economics, even aside from Mr. Wanniski's brilliant mentor Bob Mundell (who won the 1999 Nobel).
    Among other Nobel Laureates, Ed Prescott (2004) emphasizes the effect of labor taxes on work incentives. Bob Lucas (1995) emphasizes tax incentives to invest in physical capital. James Heckman (2000) and Gary Becker (1992) emphasize how progressive tax rates weaken incentives to invest in schooling and on-the-job training. And the optimal tax theory of James Mirrlees (1996) and Joe Stiglitz (2001) emphasizes both social welfare and tax-revenue (Laffer Curve) gains from low marginal tax rates on highly skilled individuals.
    The original supply-siders combined all these effects, not just one or two. Paul Krugman has yet to figure out even one.
 
    Alan Reynolds is a senior fellow with the Cato Institute and a nationally syndicated columnist.
 
 
 
 

Market Comrades
We need economic dialogue with China -- now.
By R. GLENN HUBBARD
July 26, 2005; Page A24

Ceremonial gift-giving is an integral part of doing business in China. The value lies not so much in the gift (whose packaging is often more elaborate), but in the possibility of cementing a mutually beneficial relationship.

And so it was with last week's headline-grabbing announcement that China would revalue the yuan against the U.S. dollar. The modest gesture may make more possible a comprehensive economic dialogue between China and the U.S. in the interest of both nations.

The announcement on July 21 by the People's Bank of China that it would revalue the yuan, abandoning the 11-year-old peg of 8.28 yuan per U.S. dollar, caught financial markets by surprise. The jolt led market participants to gauge effects of current (and perhaps future) revaluations on currency values and interest rates. And, some U.S. political leaders claimed a victory in the campaign to blame Chinese "market manipulation" for external imbalances facing the U.S.
* * *

But there is a bigger story here. In the first sentence of the People's Bank's July 21 announcement, the bank states: "With a view to establish and improve the socialist market economic system in China, enable the market to fully play its role in resource allocation as well as put in place and further strengthen the managed floating exchange rate regime based on market supply and demand . . . ." [Emphasis added] The inherent conflicts in the phrase ("socialist market economic system," and "market supply and demand" with capital controls and a managed float) highlight both the central economic challenges facing China and the need for a comprehensive U.S. economic policy toward China.

On the one hand, China's hesitancy to give up its currency stability is understandable. Currency stability contributed to confidence by foreign investors to build capacity in China and stimulated an export-led surge in growth that has established China's place in the world economic firmament. Now the world's seventh-largest economy (using market exchange rates), China's GDP has more than quintupled in the past 25 years. And the per capita income of China -- less than that of Ghana or Nigeria 25 years ago -- is now comparable to that of the Philippines. Chinese poverty has declined significantly, and life expectancy and literacy have improved with the fast pace of economic growth.

On the other hand, the currency peg likely has led to some capacity growth that may be uneconomic in the longer run (to the extent that the yuan was or is undervalued), and the peg limits the ability of Chinese monetary policy to cool an overheating economy except through blunt administrative controls. For an economy whose second-quarter GDP growth (announced the day before the revaluation) topped 9.5%, this question is a live one.

The revaluation of the yuan will restrain Chinese exports a bit. But this shift will have only a negligible effect on the current account deficit of the U.S., so long as national saving and investment in the U.S. are not much affected. In that sense, the strident emphasis on the yuan's foreign-exchange value by mercantilists in the U.S. Congress is a red herring.

The bigger danger of focusing on currency valuation is that the real question for China is how to promote efficient saving and investment. Improving this efficiency will make China better off -- the reason it should be on the minds of Chinese economic officials.

Sustained economic growth requires a financial system that promotes efficiency in the allocation of capital, rewarding savers and allowing the most promising entrepreneurs to achieve success. Centrally directed credit allocation can promote high rates of saving, investment and growth for a period of time, but directed credit is no substitute for the market. Japan's stumble in the 1990s as U.S. growth rose tells a cautionary tale of the advantages of a flexible economy with strong financial markets in advancing productivity growth and living standards.

China's national saving rate is extraordinary; estimated at more than 40% of GDP, it exceeds the high saving rate of Japan in its period of postwar development. This high saving rate is driven in part by demographic considerations, with rising life expectancy and an aging society with fewer workers per older individual in the future. But the Chinese financial system also contributes to high rates of saving, with poorly developed markets for consumer finance, home mortgages and insurance. And "precautionary saving" is high in China, as the public safety net for retirement, illness and disability, and unemployment insurance is weak.

Estimated at about 50% of GDP, the Chinese fixed investment rate is also extraordinary. This high rate of investment bespeaks industrial development and infrastructure in highways, telecommunications, and transport facilities, as any frequent visitor to China knows.

Here is where Chinese officials increasingly confront the conflicts of the "socialist market economy" phrase. If sustained, China's rapid economic growth will continue to enhance its role on the world stage, rivaling Japan by mid-century and eventually the U.S. and the European Union in the second half of the century. But that "if" should not be taken lightly.

In spite of China's accomplishments in raising living standards, its government-dominated banking system allocates credit poorly, and bank dominance combined with gaps in investor protection have impeded the growth of domestic capital markets. Indeed, many Western economists believe that the Chinese banking system as a whole is insolvent, with nonperforming loans possibly as large as 40% of GDP. Correcting this problem will be more difficult than banking cleanups in the U.S. and Japan both because of the scale of Chinese nonperforming loans and because of the greater cost in a poorer economy of diverting resources toward financial restructuring.

By favoring administrative fiat over well functioning financial markets, China is laying the seeds of lower productivity growth and economic growth in the future. At about 50% of GDP, China's fixed investment is almost certainly well above its efficient level, nearly three times that of the U.S. and twice that of India or the average ratio for lower-middle-income countries collectively.

Now one might observe that Chinese officials should focus only on the short run, given the need to grow sufficiently rapidly to absorb tens of millions of underemployed rural workers in more bustling cities. But the accumulation of large amounts of unproductive and poorly allocated capital only sets up a day of reckoning, with potentially devastating consequences for investment, output and employment. To ignore this political reckoning would be a significant blunder.

China has much to gain from improving the efficiency of its economic growth. The U.S. has a strong interest, too, one which should promote an exhaustive dialogue with China on economic policy. Absent reforms, surplus saving from China and other emerging Asian economies will exacerbate U.S. external imbalances and distort allocation of capital in the U.S. And the possibility of a significant correction in China in the medium run should focus American policy makers more than the protectionist rumblings in some congressional quarters.

The U.S.-Japan economic dialogue suggests constructive avenues of engagement -- encouraging market liberalization, capital-market reform, cleanup of the banking system, and improved corporate governance -- as well as discussions of exchange-rate policy. Particularly in recent years, such discussions between the U.S. and Japan have led to structural transformations benefiting Japan and the world economy. These shifts have occurred not because of American pressure, but because of the Japanese government's belief that such changes will advance Japanese growth and living standards.

The Bush administration has constructively engaged China in matters of economic reform. But the public focus on the exchange rate muddies the waters. Policies to strengthen capital markets will lead to greater domestic demand by Chinese households and an improvement in the quality of investment by Chinese firms. And U.S. assistance in designing social insurance programs can help China manage its transition to a market economy.

China's announcement last week is the modest ceremonial gift that can deepen our economic ties. We should respond with a policy dialogue good for China and for us.

Mr. Hubbard, dean of Columbia Business School, was chairman of the Council of Economic Advisers under President George W. Bush.
 
 

False Hope
By Xavier Méra   Published    07/18/2005
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  TCS

Africa was supposed to be a central focus at last week's G8 summit. But take a look at the plan to relieve African poverty. After announcing the cancelation of debt for 18 of the poorest countries --14 of which are African -- we heard it trumpeted that aid to third-world countries would be doubled, the goal being to reach $195 billion by 2015. From Tony Blair to "anti-globalization" organizations, most commentators and policy-makers portray this proposal as a great step forward in the anti-poverty fight. Whatever the intentions of the supporters of this public aid, it is more likely that finding meaningful solutions to the problem of poverty will come about through questioning these plans.

First of all, international aid is by no means a new weapon against poverty. So the benefits of doubling aid can be judged against past experience. international development aid to Africa has existed for more than 50 years. If this instrument is so efficient, how come Africa is still so poor? How come supporters of international aid justify unflinchingly the necessity to increase aid when they themselves state that the standard of living has actually fallen in the last 30 years, at the same time aid was increasing? This correlation does not prove anything but it could at least raise doubts about the efficiency of the process. Actually, there are good reasons to think that this aid is counter-productive, as an instrument of aid for development.

The term "international aid" actually refers to financial transfers between states, be they direct transfers or loans, via the International Monetary Fund, the World Bank or other international public organizations. In other words, the United States, France and other donors do not give money, food or medicine to the poorest African people but to their governments. These states are subsidized because their citizens are poor, and it is up to them to allocate the funds. This starts a completely dysfunctional chain of practice. Unless we naively consider that the politicians and bureaucrats in charge of dealing with this money are only interested in their fellow citizens' well being, we have to realize that such transfers are a source of income for them. These policy-makers are thus encouraged to avoid reforms that would result in long-lasting relief for the population, as international financing would then have to stop.

It is true that such political choices are not without cost for the recipient governments. Even the most authoritarian states cannot completely and indefinitely ignore public opinion and if the population links its disastrous situation to the decision-making of its leaders the latter risks being overthrown. This is the reason why a part of the aid is distributed even when the interest of the individuals in charge of the distribution is only about accumulating wealth for themselves. Nevertheless, the incentives given by international aid make delaying reform, and even keeping the population in poverty, worthwhile.

Thus, the international aid system has essentially served to reward policies that slow down development, whatever the initial intentions of its advocates. Under such circumstances, the implementation of the rule of law in Africa, necessary to wealth production, has been postponed indefinitely. Aid actually received by the poor is a very small compensation. If the cancelation of debt -- which they could have paid off thanks to taxation -- gives them a bit of breathing space, it won't be through increasing subsidies to their governments that their living conditions will be improved.

Xavier Méra is associate researcher at the Molinari Economic Institute.
 
 
 

Trade & Protectionism
Protectionism Won’t Save Countries from Poverty or AIDS

by Franklin Cudjoe

http://www.aworldconnected.org/article.php/1129.html

As World leaders meet in Gleneagles, Scotland to discuss the vital issues of the day, much is being made of a proposal to "relieve" poor countries of their debts and to give them more aid.  There are also plans to discuss the reduction of trade barriers, which could be a positive step towards development. But what matters most is that poor countries learn what to do and what not to do for themselves.

In that regard, we can glean much from the mistakes of the past. In the 1950s and 1960s, governments of many countries in Africa and Latin America erected walls around themselves in the form of trade barriers. The plan was to enable the industries of these countries to grow, "protected," as it were, from outside competition. What actually happened was that these industries floundered.

Although the industries in these "protected" countries grew for a brief period, the lack of competition meant that their industries became lazy and fell behind the rest of the world in both technological improvement and growth. Also, because imports were expensive or even unavailable, their costs of production rose and they continued to use old and inefficient technologies. Soon these protected industries were producing goods that few people wanted; exports fell dramatically and in many cases the industries – usually run by the cronies of corrupt leaders – had to be subsidized by the state in order to stay afloat.

Governments paid for these subsidies by taxing farmers (either directly of by forcing farmers to sell to marketing boards) and by borrowing (which is one of the reasons why so many African and Latin American countries have such large debts.) Some governments, like Brazil’s, printed money to pay off the debts--which lead to hyperinflation, reduced confidence in the economy, and resulted in massive disinvestment. Other governments, especially those in Africa, simply defaulted on their loans.

The lesson we should learn from this is that governments should not try to create national industries by protecting them from competition or by subsidizing them. The same should be said for rich countries who should stop protecting their farmers with tariffs and subsidies. Likewise, poorer countries should also stop "protecting" their industries with tariffs and other measures that result in harmful unintended consequences.

Brazil is an interesting case. It had one of the most extreme "import substitution" programs in the 1950s and 1960s, which lead to a ballooning debt during the 1970s followed by hyperinflation and, finally, a massive debt rescheduling. In the 1990s it instituted reforms that improved its economic governance, and has been growing steadily ever since. Still, there are some signs of a return to the old days.

Brazil’s government recently announced that it plans to break patents on HIV/AIDS drugs. It claims that it wants to reduce the cost of providing drugs to 180,000 people with HIV. But if it wanted to do that, wouldn’t it be better to negotiate a price differentiation scheme with the manufacturers, rather than forcing the production of drugs locally? This smacks of a return to the bad old protectionist industrial policies of yesteryear.

But there is another, more disturbing, aspect to the decision to break patents. Brazil currently benefits from the billions of dollars pumped into the development of AIDS medicines by the research-based pharmaceutical industry. As the incidence of HIV/AIDS in wealthy countries gradually declines, so demand for new drugs in those countries will wane. But AIDS remains a very serious problem in many poorer countries, including Brazil.  What would happen if all poorer countries chose to break the patents on AIDS medicines? I’ll tell you: there would be few, if any, new AIDS medicines.

Research-based drug firms seem to be taking notice of unfavorable market conditions for AIDS medicines created by the governments of Brazil and some other countries. Over the past 6 years the number of HIV/AIDS medicines and vaccines in the pipeline has decreased by over 30 percent. In 1999 there were 125 drugs and vaccines in the R&D pipeline; today there are fewer than 85. This is worrying because resistance to existing AIDS medicines is continuously rising and better new medicines will be needed to help people in the future.

Instead of pursuing dubious protectionist policies by breaking patents, the governments of middle income countries should be paying at the market price for the medicines they buy. This is of particular concern to the people of Africa, because more than half of the global number of persons infected with HIV/AIDS reside in this continent – and most of them don’t have access to drugs.

In the short term, it is unlikely that the situation in Africa will change much. Distributing drugs to all of those who would benefit from them is likely to be too costly and difficult. A major problem is that in most African countries, the health infrastructure is simply too poorly developed to be able reliably to deliver AIDS medications to so many sick people.

For us here in Africa, the real nuts to crack are corruption, excessive government regulations, poor education, punitive local tax on drugs and poor health infrastructure both in terms of personnel and material. It is significant to note also that HIV/AIDS victims in Africa especially cannot afford decent meals not to mention clean water to help gulp down anti-retrovirals. So there are real systemic, economic issues to deal.

Once we have improved the level of education about AIDS, then we in Africa can think seriously about rolling out more comprehensive programs of antiretroviral therapy. What might work for us is for Big Pharma to price discriminate, so that poor countries with severe HIV/AIDS problems pay the least, then middle income countries, then rich countries. Such an approach would provide better incentives to invest in more research for better drugs.

In the long term, governments of African countries such as Ghana should broaden access to economic opportunities through institutional reforms. The economic well being of Ghanaians remains the bulwark against the spread of HIV/AIDS.

An important first step would be decentralizing ownership and management of resources and other assets. Another would be an effective, transparent and accountable legal framework that combines effectively with respect for private property and the rule of law. The total effect is that these reforms encourage entrepreneurship and innovation, empowering people with information to make life-saving choices and enabling them to purchase insurance against deadly diseases such as HIV/AIDS.
 

Franklin Cudjoe is Director of Imani – the Centre for Humane Education, a think-tank in Accra, Ghana. Email him at franklin@imanighana.org
 
 
 
 

Friday, July 15, 2005  ~ 2:10 p.m., Dan Mitchell Wrote:
Real solutions for Africa's problems. Walter Williams and Thomas Sowell are among the best economists in America. They also happen to be black, so hopefully people will pay special attention to their cogent analysis of African poverty:

      Beginning in the late 18th century, there was a dramatic economic turnabout in Europe. How in the world did these once poor and backward countries break the "vicious cycle of poverty" and become wealthy, without what today's development experts say is absolutely necessary for economic growth -- foreign aid handouts, World Bank and International Monetary Fund loans, and billions of dollars of debt forgiveness? The answer is simple: Capitalism started taking root in Europe. Capitalism is an economic system where there's peaceable, voluntary exchange. Government protects private property rights held in goods and services. There's rule of law and minimal government regulation and control of the economy. ...Some economic development "experts" attribute Africa's troubles to its history of colonialism. That's nonsense, because some of the world's richest countries are former colonies, such as the U.S., Canada, Hong Kong and Australia. In fact, many of Africa's sub-Saharan countries are poorer now than when they were colonies, and their people suffer greater human rights degradations, such as the mass genocide the continent has witnessed. One unappreciated tragedy that attests to the wasted talents of its peoples is that Africans tend to do well all around the world except in Africa. This is seen by the large number of prosperous, professional and skilled African families throughout Europe and the United States. Back home, these same people would be hamstrung by their corrupt governments. The worst thing that can be done is to give more foreign aid to African nations. Foreign aid goes from government to government. Foreign aid allows Africa's corrupt regimes to buy military equipment, pay off cronies and continue to oppress their people.
      http://www.townhall.com/columnists/walterwilliams/ww20050713.shtml

      Many people expected great things from Africa when new independent African nations began to emerge from colonial rule in the 1960s, often headed by leaders who had been educated in Europe and America. Unfortunately, what these new leaders brought back to Africa from the West were not the things that had made the West prosperous and powerful but the untested theories of Western intellectuals and ideologues who had taught them. Such African leaders by and large lacked both the common sense of the African masses and the technological and economic experience of the West. The net result was that African leaders, full of confidence because of their Western education and the adulation of the Western intelligentsia, made their people guinea pigs for half-baked theories that had contributed nothing to the rise of the West and had contributed much to its social degeneration. ...Whatever damage European colonialism did to Africa during its relatively brief reign, that was probably less than the damage done later by well-meaning Western would-be saviors of Africa.
      http://www.townhall.com/columnists/thomassowell/ts20050713.shtm
 
 
 

The Outdated 'Swedish Model'
July 15, 2005

Even at a time when Europe's liberal social welfare policies are facing new doubts, the so-called "Swedish model" continues to find fans. Admirers claim that Folkhemmet -- a merging of folk (people) and hem (home) -- raised Sweden from its poor, agrarian origins to an industrialized nation that provides generously for human needs. From before World War II until the mid-1970s, Sweden maintained low unemployment, a high rate of growth, and an impressive social welfare system.

But a new study ("Sweden after the Swedish Model") by Mauricio Rojas, an associate professor of economic history at Lund University, calls into doubt the continued vitality of this social concept. Indeed, Mr. Rojas argues that it no longer exists in practical terms. The Swedish model began its decline long ago, he says. It had deep roots in the Swedish psyche, but the author claims it is falling victim not only to economic pressures but also to a changing sense of national identity.

Mr. Rojas contends that Folkhemmet is a model for a bygone era, brought low by the Swedish economic crisis of the early '90s. Only the privatization of public services and a ceiling on public spending since those days has kept the Swedish economy afloat. That is, what success Sweden has enjoyed in the past decade has come from the progressive abandonment of the old model.

The path of continued growth, therefore, lies in continued reform, not in any attempt to revive the old statist model. Although reform presents Sweden with challenges, clinging to an outmoded guide would be far worse, Mr. Rojas argues.

There is clearly a long way to go. Even now, over half of Sweden's GDP is soaked up by tax revenues. This is the highest tax burden in Europe. It is thus no surprise that robust economic growth is an objective Swedes consistently fail to achieve. Despite empirical evidence, the idea that the Swedish model is obsolete still runs counter to conventional thinking in much of Sweden today and, more broadly, many corners of Europe. But its declining validity in today's competitive world is something Europeans would be wise to heed.

If Sweden can learn to see itself through a new lens, it can be competitive well into the future. There might be reason for optimism. Even in Stockholm, voices demanding less regulation and more free enterprise are making themselves heard. The heavy tax burden and the welfare measures it supports is now well-acknowledged as having sapped incentives to work.

Some politicians are urging tax simplification, which is good, but over time, Europe's competitiveness will depend on taxes and spending coming down in both absolute and relative terms. The most innovation is occurring at the edges of Europe, by those countries embracing globalization, such as Ireland and the Central European states. Those economies following the French-German social model are stagnating.

For Europe to learn from Sweden's mistakes, it will have to acknowledge that the much praised "model" is now an anachronism. Mr. Rojas has made a contribution to that understanding by pointing out that even the Swedes have their doubts.
 
 
 
 

Vietnam's Mixed Record
June 21, 2005
 

Hanoi has opened the economy but forgot human rights.
 

"Now that 30 years have elapsed since the end of the war, it is our policy to put aside the past and look to the future and a better relationship between the two countries."

--Vietnamese Prime Minister Phan Van Khai, speaking on the eve of his current visit to the U.S., the first by a senior leader since the end of the Vietnam War.

These are fine sentiments, and the Bush administration will likely welcome Mr. Khai's willingness to put the past behind him. Mr. Khai will meet with President George W. Bush and Defense Secretary Donald Rumsfeld today, and both men recognize the benefits of stronger military and intelligence ties with Hanoi.

But Washington should also make clear that Hanoi will not make friends abroad as long as the Vietnamese people are subject to political and religious repression.

To be sure, Vietnam has made great strides over the years, at least on the economic front. The U.S. ambassador to Vietnam, Michael Marine, said in a recent speech that "Vietnam represents arguably the most dynamic market in Southeast Asia today, second only to China in all of Asia in terms of economic growth rates over the past 10 years." The Vietnamese economy has been growing by about 7% in recent years, and hitting 7.7% in 2004. As Jonathan Stromseth points out nearby, economic success is in part thanks to domestic reforms that led to dramatic private-sector growth.

Another boon for the economy has been trade with the U.S., which was buoyed by a bilateral trade agreement that took effect in 2001. In the last three years, bilateral trade between the U.S. and Vietnam has increased by a whopping 325%. Vietnamese exports to the U.S. reached $5 billion last year, and the U.S. is now Vietnam's largest overseas market, purchasing one-fifth of all Vietnamese exports.

Mr. Khai would like to further unleash Vietnam's trade potential. One of his goals on this trip is to try to get Washington's help to speed up Vietnam's accession to the World Trade Organization. As a nonmember, Vietnam is still subject to the outdated quota system that expired for members at the end of last year.

U.S. investment in Vietnam is rising, and Vietnam has also attracted U.S. companies by creating a reputation for producing high-quality goods. Perhaps more importantly, U.S. retailers who don't want to put all their eggs in one basket recognize Vietnam's appeal as an alternative to China. One buyer who represents major U.S. retailers told us that she is concerned China's supply won't match demand, in particular for goods requiring skilled labor. "China is high-risk because everyone is going to China," she told us.

Now for the bad news. These blossoming economic reforms in Vietnam simply have not been accompanied by political reform in the area of human rights. The press and Internet remain under state control. There are no private newspapers. Hundreds of dissidents have been jailed on criminal charges merely for advocating democratic reforms, or spreading proposals for human rights and religious freedom.

Followers of religions that are not officially recognized by the government are persecuted, and the authorities continue to target ethnic minority Christians, Mennonites, Cao Dai followers and various Buddhist groups. Violations of religious freedoms led the U.S. to designate Vietnam as a "country of particular concern" last year. Thanks to U.S. pressure, Hanoi promulgated legislation aimed to ban forced recantations of Christianity and loosening up requirements for Christian churches to register with the government. But according to Human Rights Watch, authorities continue to force minority Christians to recant their faith, and hundreds of political and religious prisoners remain behind bars.

Mr. Bush will likely welcome the possibility of a new friendship in Asia at a time when China's influence is growing in the region and in the world, and Mr. Khai clearly wants to polish up Vietnam's image abroad. Vietnam is a country that has never held a romanticized view of China. This trip offers the Bush administration an opportunity to reinforce the point that the way to gain respect abroad is to partner economic development with progress in human rights.
 
 

Don't Panic Over Delhi's Deficit

By VIVEK MOORTHY
June 20, 2005

India's large fiscal deficit is routinely cited as the biggest threat to its currently robust economy. The sum of the fiscal deficits of the central government and states was close to 10% of GDP in the fiscal year 2003-04, roughly the same as in 1990-91, the year when a severe balance of payments crisis set the country on the road to reform. For more than a decade, analysts have been telling the politicians that their spending is unsustainable and will sooner or later bring on another crisis. However, while India does need to find a political formula to regulate spending, the situation is not as dire as some have predicted, and indeed the crisis mentality has spurred some misguided measures.

That's because within India most of the Parliament's attention has focused on another measure of spending, the revenue deficit, an indicator that is not even reported in many other countries. Roughly speaking, the revenue deficit is the fiscal deficit less the government's capital expenditure, such as on infrastructure projects. A revenue deficit implies the government is borrowing to finance current expenses, and not spending on productive capital assets vital for growth. Hence the country is considered to be living beyond its means, a precursor to financial ruin.

As the graph nearby shows, during the 1990s the combined center-state revenue deficit doubled to 6% from 3% of GDP, ostensibly a severe fiscal worsening. The immense concern of Indian policy makers with the high revenue deficit led to the framing of India's Fiscal Responsibility and Budget Management Act (FRBMA). The crux of this legislation was a target of a zero revenue deficit to be achieved within five years.

First introduced in Parliament in 2000, the original bill also stipulated a 2% of GDP fiscal deficit target. A modified version abandoning the fiscal deficit target but maintaining the zero revenue deficit target was adopted by both houses of Parliament in 2003. Following the lead of the central government, a few Indian states have also enacted their own Fiscal Responsibility Acts with revenue deficit targets.

In the very first year after its enactment, however, the law's target was breached. Roughly 2.5% of GDP when the law was enacted, the revenue deficit is supposed to be steadily reduced to zero over five years. For the current fiscal year 2005-06, the FRBMA revenue deficit target is 2.0%, but the budget projection shows a much larger deficit of 2.7% of GDP.

The current setback provides an opportune moment to scrutinize India's entire fiscal predicament. The logic underlying the FRBMA is fundamentally flawed, and the particular circumstances underlying India's revenue deficit mean that its rise should be ignored. India's fight to rein in spending has been hampered by unrealistic goals targeting wrong indicators. Instead of focusing on the revenue deficit, lawmakers should shift their attention to a primary deficit target, i.e., the fiscal deficit less interest payments.

Is a Revenue Deficit Harmful?

For a private company, a zero revenue deficit is a must and a revenue surplus is highly desirable. If a company borrows only to meet current expenses (i.e. salaries etc. plus interest) instead of borrowing to build or purchase equipment, its stock of productive assets will diminish, and its sales and hence net revenue will decline at some point. The drop in revenue will lead to further borrowing to pay interest, and worsen the revenue deficit in a vicious circle. A revenue deficit is thus financially ruinous for a company.

However, the same constraints do not apply to national finances. The growth of a country's sales (i.e. private sector GDP) and thus government tax revenues results not only from government investment but also from private sector investment. As long as private sector investment is adequately high, the economy's growth rate can comfortably exceed the (average) interest rate on government debt. In most economies this is usually the case.

As long as this "Domar condition" (GDP growth rate should be higher than the interest rate) is satisfied for a given primary deficit, the government can forever run a revenue deficit with all fiscal variables remaining stably under control. The government can use the "dividend" from (private sector) growth to keep paying off the interest on debt. If the private sector as a whole runs an adequate revenue surplus, that should usually ensure enough investment to generate GDP growth higher than the interest rate. The nation as a whole can build assets even while the government continues to run a revenue deficit.

Indeed, in most developed, free-market economies the creation of productive assets (which includes education and training) comes mainly from private-sector activity. The role of the state is primarily to undertake critical revenue expenditure on legal infrastructure such as the police, judiciary and also on social welfare. Barring critical infrastructure projects, the government need not engage in capital accumulation, which should come mainly from the private sector. Furthermore, much of the new infrastructure can be paid for through user charges and by private financing. Thus deficits in developed countries are mainly revenue deficits.

Like a private company, a public sector commercial entity such as Indian Railways (IR) needs to run a revenue surplus. However, India is not a company, and IR is not the government of India. This fundamental distinction seems to have eluded India's policy makers.

The economic logic underlying the FRBMA was very relevant to an era when the government directly, or through its public sector commercial enterprises, made huge investments in steel, coal and railways (the private sector was banned from entering) that were a major source of growth. This was so in the mixed, semisocialist economy of the 1960s and 1970s, but is no longer true in an increasingly private sector dominated economy. The mindset of the policy makers was shaped by the old environment, and so the FRBMA was not geared to this new economy.

Setting Realistic Goals

Reduction of the revenue deficit to GDP ratio by 50 basis points a year would require raising taxes significantly, since spending cannot be cut easily. Indeed the roadmap for FRBMA implementation is focused on higher tax revenue. The target is supposed to be achieved by broadening the tax base via more service taxes, higher service tax rates, and increased collections with the advent of a nationwide value added tax that went into effect on April 1, 2005. However, as this year's budget outcome shows, it is not politically feasible to raise taxes.

Feasibility apart, such sharp increases in taxes will have negative (short-term) demand effects, as Keynesian economists emphasize. They could also have a supply-side effect of deterring investment and production. The risks of a recession are severe, and hence it may not be desirable to raise taxes so sharply. The revenue deficit target should be formally scrapped, or else it is likely to die a natural death.

Focus on the Primary Deficit

This is by no means intended to deny that India does face a fiscal crisis. With the combined center-state debt-to-GDP ratio now close to 80%, the fiscal situation needs serious attention and suitable legislation. Fiscal control should be achieved mainly by Constitutional rules that preemptively cap spending, not by numerical ratios that reactively trigger spending cuts as the FRBMA attempted to do. Along with these rules to curb spending up front, some numerical deficit targets would need to be an integral part of fiscal legislation.

Keeping some statutes of the FRBMA intact, new legislation should be introduced with a primary deficit target. The Domar condition indicates that under normal circumstances, i.e. with growth higher than the interest rate, the fiscal situation can worsen only if the primary deficit rises.

The primary deficit is the root cause of real fiscal problems and policy makers should redraft legislation accordingly. A modest, primary deficit target is most likely to ensure that what at present is a manageable fiscal burden does not spiral into a full-blown crisis.

Mr. Moorthy is a professor of economics at the Indian Institute of Management in Bangalore, India. This is an edited extract from the June issue of the Far Eastern Economic Review (www.feer.com).
 
 
 

India's Far From Free Markets

By AMIT VARMA
June 16, 2005

Indian Prime Minister Manmohan Singh is due to visit Washington in a few weeks, and editorialists and commentators have already started writing about the emerging economic power of India. New Delhi's decision to start liberalizing its economy in 1991 is touted as a seminal event in India's history, the moment when it threw off the shackles of Fabian socialism and embraced free markets. It is the stuff of myth -- and to a large extent, it is exactly that.

While part of India has benefited from being opened up to foreign products and influences, most of the country is still denied access to free markets and all the advantages they bring. India opened its markets in 1991 not because there was a political will to open the economy, but because of a balance-of-payments crisis that left it with few options. The liberalization was half-hearted and limited to a few sectors, and nowhere near as broad as it needed to be.

One would have expected India's growth to be driven by labor-intensive manufacturing but, almost by default, it instead came in the poorly licensed area of services exports. The manufacturing sector, ideally placed in terms of labor and raw material to compete with China, never took off. India's restrictive labor laws, a remnant of the socialist infrastructure that India's first prime minister, Jawaharlal Nehru, put in place in the 1950s and 1960s, were politically impossible to reform. It remains excruciatingly difficult for most Indians to start a business or set up shop in India's cities.

This is painstakingly illustrated in "Law, Liberty and Livelihood," a new book edited by Parth Shah and Naveen Mandava of the Center for Civil Society in New Delhi, which documents the obstacles in the way of any Indian who wishes to start a business in one of India's big cities. Messrs. Shah and Mandava write: "Entrepreneurs can expect to go through 11 steps to launch a business over 89 days on average, at a cost equal to 49.5% of gross national income per capita." Contrast the figure of 89 days with two days for Australia, eight for Singapore and 24 for neighboring Pakistan.

But often, even this figure is just a notional one, and entrepreneurs find it next to impossible to get a legal permit to start a business at all. Street hawkers and shop owners in the cities often cannot get a license at all. (Even those who do have to comply with draconian regulations that offer so much discretion to the authorities that corruption is inevitable.) They survive by paying regular bribes to municipal authorities and policemen, which are generally fixed in such a way by this informal market that they can barely survive on what they earn, and cannot expand their business or build their savings. They are trapped in a cycle of enforced illegality and systematic extortion by authorities, which results in a tragic wastage of capital. It serves as a disincentive to entrepreneurship, as well as to urbanization, the driving force of growing economies.

Another disincentive to urbanization is how hard it is for poor people to get legal accommodation in the big cities. In Bombay, for example, an urban land ceiling act and a rent-control act make it virtually impossible for poor migrants to rent or buy homes, and they are forced into extralegal housing. The vast shantytowns of Bombay -- one of them, Dharavi, is the biggest slum in Asia -- hold, by some estimates, more than $2 billion of dead capital. For most of the migrants who live in these slums, India hasn't changed since 1991. As that phrase from India's pop culture goes, "same difference."

India's policymakers are aware of these anomalies, but it is an acute irony in India that any proposal to reform the bureaucracy has to first wind its way through the bureaucracy. Arun Shourie, a former disinvestment minister and a respected journalist, wrote in his recent book "Governance" that, "proposals for reforming [the] system are adopted from time to time, and decrees go out to implement the measures 'in a time-bound manner.' But in every case, the proposal is put through -- some would say, it has to be put through -- the same mill."

It is in the nature of bureaucracies, Mr. Shourie points out, to endlessly iterate. He charts how the apparently simple task of framing a model tender document took the government more than 13 years, as drafts of it circulated between different committees and ministries. Anything even slightly more complicated, and with pockets of political opposition to it, like economic reforms, becomes almost impossible to implement. Dismantling state controls is only possible if there is political will and a popular consensus. None of these exist. On the contrary, there is a popular belief that the economic inequalities in India are caused or exacerbated by free markets.

The socialist left, a natural proponent of such views, believes that free markets are the problem and not the solution. India's communist parties have blocked labor reform, opposed foreign investment and prevented privatization of public-sector units. They naturally have a vested interest in the "license-permit-quota raj," as the web of statist controls is called. On all these issues they are supported, surprise surprise, by the religious right.

The Hindu right wing, led by the Bharatiya Janata Party and collectively known as the Sangh Parivar, also fears globalization. Its sustenance comes from identity politics, the impact of which is diluted by the opening up of the cultural mindspace to "foreign influences." If people are busy chasing prosperity and gaining Western liberal values, they will naturally have less time to focus on "the Hindu identity," and suchlike. Rabble rousers need the masses to be disaffected.

In between the socialist left and the religious right is the Congress, a party which occupies the center of the political space almost by default. Its position on issues is always malleable, and although it is currently the party of government, it leads a coalition that depends on the left for survival. The pace of reforms has not increased since it came to power last year, and is not likely to do so anytime soon. While the world focuses on the metaphorical bright lights of Bangalore, most of the country -- indeed, much of Bangalore itself, which has been plagued by power and infrastructure problems recently -- remains in darkness.

Mr. Varma is based in Bombay and writes India Uncut, a popular Indian blog (http://www.indiauncut.com).
 
 
 

Alvin Rabushkas site
http://www.russianeconomy.org/comments/060605.html
 
 
 
 

Sweden's Hidden Jobless
Labor Economist Asserts
Unemployment Near 20%

By TERENCE ROTH
DOW JONES NEWSWIRES
May 27, 2005

STOCKHOLM -- Jan Edling, a little-known labor-union economist, is suddenly in the policy spotlight with his assertion that Sweden's real jobless rate is really closer to 20% than the official 5.5% rate.

He resigned last week from the big LO blue-collar union where he worked after the association declined to publish his research project into Sweden's hidden joblessness. Instead, he posted it online.

"My suspicion is that we are putting people into other benefit categories that other countries would put into the unemployment column," Mr. Edling said.

That Sweden has far more people out of work than detailed in the official 5.5% unemployment rate isn't totally new. Beyond the official rate, an additional 4.4% of the working-age population are parked in the government's elaborate array of job-creation and training programs, according to a study by Skandinaviska Enskilda Banken AB with data from Statistics Sweden.

But Mr. Edling calculates that another 10% of working-age people can be identified as unemployed, using correlations between unemployment, long-term sickness and early retirement among Sweden's municipalities and regions. This makes the actual unemployment rate closer to 20% of the work force, he said.

The paper kicked up a storm in left-wing politics, making him an overnight celebrity among Sweden's lonely free-market advocates. The LO union called for a quick debate on the issue Wednesday, featured prominently on national television. Another of its economists wrote a quick refutation of Mr. Edling's theory and methodology. It denied that the report was suppressed. It said Mr. Edling's paper needed more evidence to show that large ranks of Swedes on sick leave and in early retirement are unemployed by another name.

The tempest Mr. Edling has caused will likely subside before his theory can be conclusively proven or dismissed. But it has made unemployment a big issue in time for the 2006 elections. It is the social-democratic government's hot-button policy issue, with the jobless rate steadily rising in recent years.

Finance Minister Paer Nuder said Wednesday that Sweden's unemployment data are collected according to international standards. But, without discussing the additional numbers, he acknowledged that Sweden's jobs issue goes further than the number of registered unemployed.

"We have two problems here. We have a problem with unemployed people and we have a problem on sick leave. But you shouldn't mix these problems," he said.

Mr. Nuder also defended the government's recent additions to jobs programs and new plans to help return the long-term unemployed to the work force.

"Obviously, the market is not able to find these kinds of jobs," he said. He observed that in other countries such job candidates will need to work two jobs to make ends meet. "That's not the Swedish way."

"You're not allowed to say that in the unions," said Johnny Munkhammar, an economist at the Timbro free-market think tank. "The Social Democrats and the unions are very close. Employment will be the government's biggest issue ahead of the election, but the reality is against them."

Mr. Edling, pointing out that similar numbers to his had been under discussion behind closed doors, said that the Social Democrats and unions are "afraid of having a debate that right-wing parties will take advantage of."

The LO union denied that the report was suppressed. It said Mr. Edling's paper needed more evidence.

"There are some people who are early retired that are so because they were unemployed. The question is how many," said Mats Morin, another LO economist who wrote the union's rebuttal. "It raised more questions than answers," he said.

But government critics see other signs as the drumbeat of major companies shifting jobs overseas continues. Electrolux AB, General Motors Corp.'s Saab unit and the Swedish operations of International Business Machines Corp. are only the most recent to have joined the list.

Mr. Edling, a union employee of 18 years, doesn't relish his notoriety, nor does he see himself breaking party ranks.

"I'm still loyal to the LO and the Social Democratic party. I'm still the same person I was," Mr. Edling said. "I didn't expect this to happen."

He also believes he is being misunderstood. Instead of urging the overhaul of the labor market and welfare and tax regime, his aim was to show that regions investing heavily in infrastructure, research and education for job mobility did better than regions that didn't. Typically, he said, the latter had more hidden unemployment.

"The public debate is about statistics, but they are only a symptom of something that is wrong in this country," Mr. Edling said. "What we see are people at Electrolux who lose their jobs and don't know anything else than how to make vacuum cleaners. Chances are they will soon be in early retirement."

Write to Terence Roth at terence.roth@wsj.com
 

June 3, 2005

Why the Ideas of the World Bank Come Up Short

by Robert E. Anderson

Robert E. Anderson, an economic development consultant and former World Bank economist, is the author of the book Just Get Out of the Way: How Government Can Help Business in Poor Countries (Cato Institute 2004).

Paul Wolfowitz's appointment as president of the World Bank should revive the debate about the aid agency's effectiveness. One way of improving performance is by giving good advice.

For example, economic growth is the most powerful way to reduce poverty, and the World Bank recognizes that a healthy private sector is the only way to increase growth. Thus, the Bank advises poor countries to improve their business environment.

But the World Bank too often recommends the sophisticated policies found in rich countries without seeming to recognize that poor countries cannot successfully implement them. The result is often a worsening of private-sector performance.

Instead, the Bank should take into account the institutional weaknesses typical of developing countries: low skills, corruption, and the influence of special interests. Following are some examples.

It is generally accepted that governments need to privatize state-owned companies. But politicians with World Bank support often adopt complex methods of privatization. The politicians hope to keep partial government ownership and control or to enrich themselves and their cronies. A simple and transparent method is to sell 100 percent of the company to the highest cash bidder. The winning bidder is likely to have the best plan for improving the company's performance.

Governments also use privatization to create a large stock market by selling shares to many small investors. The recent corporate scandals both in Europe (Parmalat) and the United States (Enron and WorldCom) should raise doubts about the wisdom of the World Bank encouraging widespread share ownership in countries where holders are unlikely to be protected because of weak rule of law and poorly performing regulatory bodies.

Fierce competition is necessary to spur private businesses to improve performance. The private sector, naturally, tries to convince the government to limit competition -- for example, by imposing high tariffs on imports and restricting entry by new firms.

The bank does advocate the removal of these barriers to competition. It also recommends that governments create competition agencies with wide discretion to intervene in the private sector.

The outcome is that private companies are likely to manipulate these agencies to reduce rather than to increase competition. For example, companies allege that their competitors are engaged in predatory or discriminatory pricing when their only crime is reducing prices.

Historically, developed countries allowed only two options to bankrupt firms: a voluntary restructuring negotiated between the firm and its creditors or liquidation by bankruptcy court. The recent trend, however, is to encourage a third option: The government or bankruptcy court decides whether and how the firm will be restructured -- Chapter 11 bankruptcy, for example. The usual justification for this option is that it will preserve jobs.

Allowing this option in developing countries where bankruptcy courts are even more subject to political pressure permits backward and inefficient companies to survive. One of the biggest obstacles to modernizing the Russian economy is that politically directed bankruptcy procedures let old, former state-owned companies dominate markets and keep out modern ones.

Perhaps the biggest obstacle to reducing poverty has been the miserable performance of banks. State-owned and private banks in developing countries have frequently become pyramid schemes whose assets are mostly bad loans.

As a result, two-thirds of developing countries during the last 25 years have experienced one or more banking crises in which large numbers of banks have failed. Governments have spent more that US$1 trillion in bailing out these banks so as to protect depositors.

The World Bank's response to this massive government failure is to recommend the type of bank regulation and deposit insurance used in most developed countries. This is surprising, given the fact that two-thirds of developed countries have also had widespread bank failures, like the S&L scandal in the United States. If developed countries have difficulty in making this regulation work, can Bangladesh or Tanzania?

Is there an alternative? One that holds promise is used by New Zealand. That country regulates bank deposits as it does any other financial security, such as stocks and bonds, and does not guarantee bank deposits. In other words, depositor beware.

When asked about the inability of governments in developing countries to implement sophisticated policies to improve the business environment, the World Bank says that it will provide training and technical assistance. Maybe this will be successful someday. It is easy for World Bank experts to recommend what they know -- namely, the policies in the developed countries.

But it takes courage and imagination to recommend innovative policies that developing countries can implement now.

This article appeared in Investor's Business Daily, May 9, 2005.

Why Can't the World Bank Be More Like a Bank?

By JAMES S. HENRY and LAURENCE J. KOTLIKOFF
June 1, 2005; Page A20

Today begins Paul Wolfowitz's tenure as president of the World Bank. And if he doesn't have first-day jitters, he should.

Mr. Wolfowitz faces a huge challenge -- delivering massive amounts of development aid in a way that can't be expropriated or exploited by corrupt Third World bureaucrats or the avaricious development industry. This "aid delivery tax," evidenced most recently in the U.N. food-for-oil scandal, rips off intended recipients by limiting not only what they get, but also what donors are willing to give. In addition, the form of aid is often distorted to satisfy the "development" priorities of local officials and businessmen. The World Bank has often supported huge infrastructure projects, when buying mosquito nets or organizing vaccinations would have been much more cost-effective.

Fortunately, thanks to new technology, there is now a direct way to assist people in the Third World, namely via World Bank accounts. Under this proposed policy, the Bank would establish, manage, and oversee individual accounts for citizens or institutions in Third World countries, as well as directly contribute to those accounts. New technology -- electronic fingerprint recognition -- can be used to ensure that only one account is opened for any given Third Worlder.

The accounts would serve three functions: checking, saving and investing. All account balances would be invested by the World Bank in a market-weighted global index fund of stocks, bonds and real estate securities. The accounts would be the private property of their owners, who would be free to add to or withdraw from their balances via ATMs located at home or abroad. Since portfolio holdings would be marked-to-market, account owners would be able to write checks against their account balances. Balances in the account could also be used to secure micro-lending, which is working very well in countries like Bangladesh, Mexico and Colombia. Finally, the accounts would be free: The World Bank would charge no fees.

Overnight, developed countries, other development banks, NGOs, private charities, and private individuals would have a means of directly helping Third Worlders. They'd simply write out a check to the World Bank, designating the country they wanted to help. The Bank would then uniformly increase the balances of all account holders from that country. Recipients could either save the money and have it automatically invested in the global capital market, withdraw the money in local currency or a major currency of their choosing, electronically instruct the Bank to issue payments, or use their account balances to make electronic purchases. The purchases could include subsidized medications and other essential items, which the World Bank could sell through an electronic store accessible, via ATMs, only to Third World account holders.

The World Bank would also accept and deposit checks made out to individual account holders. This would allow employers to help their workers save. It would also provide a secure and inexpensive conduit for worker remittances. Remittances from Third World "guest workers" now exceed official development assistance by a factor of two. But most of these transfers are made at incredibly high transactions costs.
* * *

Our "show-them-the-money" approach to development assistance might be dubbed "financial populism." It provides the world's poorest inhabitants not only with direct access to development aid, but also with free access to four financial services that have heretofore been available only to First Worlders and the Third World's richest: a safe depository of savings; portfolio diversification; access to the world financial market's high average rate of return; and easy access to credit.

As any Argentine will explain, these services are vital to individuals and the economy. Four years ago, Argentina's financial system collapsed. Its banks reneged on their deposits; its treasury reneged on its debt; and its central bank reneged on its currency. Millions of ordinary people, with every peso or dollar invested in Argentina, lost their life's savings -- followed by their jobs -- as the economy headed down the tubes. Argentina's fiasco is just the latest case of financial abuse meted out to the world's poor by local bureaucrats and bankers who routinely limit financial freedom for their own political and rapacious ends and then make a hash of their country's fiscal and monetary affairs.

Prior to Argentina there was Turkey in 2000, Russia in 1998, Thailand in 1997, Mexico in 1994, Bolivia in 1984, Chile in 1982, and others. The common thread in these crises is that the common man has had no place to hide. The World Bank's misguided policy of "domestic capital market development" has operated under the absurd presumption that each country has a comparative advantage in providing financial services and that each should have its own stock exchange, bond market, pension industry, insurance companies, not to mention banking system and regulatory institutions. And to ensure that homegrown financial institutions have customers, the Bank has forcefully, if subtly, supported restrictions on foreign investment by domestic residents. Were Rhode Island a Bank client, the Bank would be doing its level best to ensure no Rhode Islanders ever invested a penny outside that tiny state. Were that the law, the Rhode Island government would quickly find it could sell lots of state bonds at low interest rates to its financially captive public. This, in turn, would facilitate additional government spending.

Hard to believe? Well, just look at Kazakhstan, Mexico and Uruguay, whose Bank-supported "pension reforms" have ended up with pension companies holding nothing but government paper and charging their coerced participants large fees for what is ludicrously called "investment management."

By establishing World Bank accounts, the World Bank would end, rather than contribute to, Third World financial servitude. This would limit excessive borrowing and spending by Third World countries and force domestic financial institutions to meet the international market test, i.e. to compete. By breaking the chains of financial bondage, the new policy would also force developing countries to adopt the legal and accounting norms needed to attract foreign investment. In plain terms, countries like Argentina would find they have to start acting like Luxembourg if they want to have either their own citizens or anyone else invest at home. And once they did, they'd experience a flood of First World capital ready to work in their countries.

Thus World Bank accounts hold the promise not just of revolutionizing the delivery of aid, but also of limiting the potential for banking, currency, and fiscal crises in the developing world. Banking crises in places like Argentina will either become a thing of the past or there will be no banks left in Argentina to go into crisis. The government would no longer have a captive market for its bonds, and would either get its fiscal house in order or find no takers for its paper. And the Argentine central bank would either maintain a stable value of its currency or quickly learn that no one wants or needs to use it. In short, it's time for the World Bank to fulfill its obligations to the world's poor. The path is simple. It just needs to start acting like a bank.

Mr. Henry is editor of Submergingmarkets.com. Mr. Kotlikoff is chairman of the department of economics at Boston University.
 
 
 
 

Damaged goods
May 19th 2005
From The Economist print edition

The American economic model is doing all right. It could be doing even better

LOOKING around the world, you do not see many economies, least of all rich ones, doing as well as America's. In the inexhaustible capacity of its private sector to innovate, in its seemingly unquenchable desire to reinvent itself, the United States still leads the world, and reaps the material rewards of that leadership. Its brand of capitalism appears to have something going for it—so it may seem churlish, even perverse, to wonder how much better a country as successful as this might do if it really tried. And yet it could indeed be doing better. That's right: American capitalism is not beyond improvement.

In 2001-02, at the height of the Enron scandal, and amid the other corporate debacles that stained the reputation of American business, that would have seemed too obvious to be worth stating. But concerns about corporate probity have receded of late. This is for a variety of reasons. One of them, or so its designers hope, was the Sarbanes-Oxley statute, the measure conceived in response to those scandals. But that law is not in fact proving to be the unalloyed blessing that its creators envisaged. Meanwhile, other flaws in the American business model remain unattended to; they were simply not addressed by SOX (as it is now, not always affectionately, known). So, pleasant though it must be for the United States to contemplate the current performance of the continental European alternative, it would be wrong, as well as unAmerican, to be complacent. There is still some work to do at home.

Repent at leisure

The trouble with Sarbanes-Oxley is that it was designed in a panic and rushed through in a blinding fervour of moral indignation. This is not to say that the problems it addressed were imaginary. The calamities at Enron, WorldCom and the others warranted remedial action. And accounting failures—the focus of SOX's efforts—were undoubtedly among the things that went wrong. But it would be difficult to argue that mere book-keeping was the main thing. Yes, it is outrageous that the true state of those companies was disguised. But when firms collapse that way, it is usually because they have borrowed too much and squandered the money. Accounting impropriety may conceal those errors, for a time, but is hardly ever the main cause. Bad business judgment, with or without criminal intent, is far more often to blame. And bad economic policy can sometimes contribute to bad business judgment.

Sarbanes-Oxley was right to attack the long-recognised conflict of interest in the audit profession, and to put some distance back between a company's auditors (who are there to safeguard shareholders' interests) and its managers (who sometimes forget that that is their job too). This needed to be done, and in fact the act might have gone even further in this respect. But the statute, carried along by rage and by the desire of Congress to do something dramatic, ranged wider than was necessary to achieve that particular goal. Its daunting requirements on managers, with the threat of severe criminal penalties to back them up, are imposing substantial costs, direct and indirect, on American business (see article).

The book-keeping industry, having been fingered (wrongly) as the main culprit in the great scams of recent years, is suddenly elated: thanks to Congress, its incomes are soaring. On the other hand, many of the men actually running American business, not all of them robbers or frauds, are dismayed. Congress has made their job harder—and, ultimately, it is the economy at large that will bear the cost. Fortunately, some of this excess burden is already being lightened, as calls for a less rigid interpretation of the law are heeded. More “flexibility” of that sort, as it is called, would be welcome.

A world beyond audit

The rest of a suitably ambitious agenda for improving the performance of American capitalism might run as follows: genuine, as opposed to phoney, corporate-governance reform; tort reform; tax reform; and corporate-welfare reform. The Bush administration seems to be keen on some parts of this package, but is decidedly opposed to others.

The challenge for corporate-governance reformers is easily stated: to hold managers more accountable to shareholders. However, one can only expect so much of auditors, with or without SOX, or regulatory agencies, of which America has no lack. It would be more fruitful to pay attention to the market for corporate control. Nothing is better calculated to make managers concentrate on pleasing the owners than the threat of a possible takeover. Policy should aim to invigorate this market—whereas at present, through an unplanned accretion of statutory and judicial interventions, it does the opposite.

The Bush administration rightly advocates tax reform and tort reform, both of which are needed to iron out mangled economic incentives. But advocacy is no substitute for action. The tax system cries out for radical simplification—which is apparently not what Mr Bush intends. Recent changes to the taxation of dividends have helped to lessen the tax code's bias in favour of borrowing, but this harmful distortion has by no means been removed. It is one of the main ways in which policy leans on households and businesses to take bigger financial risks than they would if left to their own devices.

A fine way to deal with this would be to cut corporate taxes (against which debt service can be deducted, hence the pro-debt bias); and an excellent way to pay for that would be to launch an assault on corporate welfare—the $100 billion a year or so, conservatively estimated, of special-interest subsidies and handouts that the government pays to American businesses. Preferably, don't just cut that lot, eliminate it.

This last recommendation is one that George Bush will be especially reluctant to accept. Mr Bush is the classic instance of a conservative politician who confuses support for particular businesses with support for enterprise in general. These seemingly similar ideas are in fact directly contradictory. The way to support enterprise—American enterprise, the best in the world—is to be as unEuropean as possible. Mr President, look at France. Notice their economic policies. See how they subsidise this and protect that. Do we have to spell it out?
 
 
 
 
 

After the Haircut, Argentina Readies the Shave

By MARY ANASTASIA O'GRADY
May 27, 2005; Page A13

It's taken almost three and a half years, but Argentina is close to completing the restructuring of most of the $80 billion -- face value -- in debt that it defaulted on in December 2001. Some 24% of bondholders refused to participate, yet the restructuring, which trades the original bonds for new paper at a haircut of roughly 70%, is widely considered a success.

The bond swap closes only the latest chapter in a dismal financial history, checkered with debt moratoriums and bouts of pernicious inflation. But the epic tragedy of Argentina's slow and tenacious decline from a world-class economic power to world-class basket case remains a work in progress.

Any hope that the 2001 crisis might have been used to bring about constructive reform has been lost. Argentina has enjoyed two years of strong rebound growth from the 2002 recession but, going forward, growth won't come so easily. With competition for capital around the world heating up, a mediocre ability to raise funds is now the optimist's vision for Argentina's future.

President Nestor Kirchner greeted the bond swap with qualified enthusiasm. "Consolidation of the debt exchange will result in growing investment," he reportedly told Argentina's Radio Diez on Tuesday. "It's not going to be an explosion, but more like a gradual process."

That's not exactly a ringing endorsement of his own economic program -- and no wonder. By now even Mr. Kirchner and his atavistic Peronist Party must understand the link between government policy and investment. Making Argentina a prime destination for international investment would require an economic restructuring inconsistent with populist Peronism -- thus the need to keep expectations low.

It is always at least moderately amusing to listen to this government parse its own economic agenda. On the one hand it denounces the savagery of market economics -- so as to keep its labor base and its hard-left, picketing militants happy -- and on the other hand it flirts with investors by insisting that it does not endorse statism.

Last week Economy Minister Roberto Lavagna awkwardly tried to define his place on that continuum. As Dow Jones Newswires' Michael Casey reported from Buenos Aires, the minister said that he is neither a "prophet of chaos" from the 1990s (a reference to market economics) nor an "alchemist[s] of a prosperity without cost," who supports 1970s "populism."

Had Mr. Lavagna made a distinction between the half-hearted so-called market reforms of the 1990s and true, competitive markets, there might be cause for optimism. But these comments appear more like an apology for the "Third Way" of watered-down socialism.

A May 24 report from the Economist Intelligence Unit described the government's internal conflict, which, despite Mr. Lavagna's denial, seeks prosperity but not at the price of allowing creative destruction to alter the economic status quo. It "heralds a departure from the free-market policies of the 1990s which are now widely criticized in Argentina, but it will also try to attract new investment by gradually re-establishing stable rule and property rights," the EIU wrote.

The EIU's advice to investors was, don't get your hopes up. "Business should plan on a return to smooth government operations taking a long time. In the transition period they should be prepared for uncertainty, substantial delays and red tape in dealing with the Argentine government."

Ditto for tax policy, where the EIU expects corporate tax increases will be sought as a way to close the fiscal gap and says the system carries a "high risk" of "frequent changes." Depressed personal incomes make the probability of personal tax rate hikes low, therefore "companies -- particularly foreign entities -- could bear the brunt of any hikes in marginal tax rates. Foreign companies should plan for the possibility of higher tax rates."

The government is also utilizing price controls to combat inflation, and not only on transportation and utilities. There are also "tacit" price-control agreements with "dairy producers, petrol retailers and some pharmaceutical companies," a separate EIU report noted the same day.

Nor is Argentine trade policy up-to-date. Heavy reliance on the protectionist South Cone customs union known as Mercosur to expand Argentine export markets has resulted in extensive trade diversion with Brazil. But, without access to imports from the rest of the world, Argentine producers have little hope of discovering comparative advantages in new value-added businesses or gaining competitiveness. Argentines have to be satisfied with being Third World commodity exporters and brace for the next downturn in world prices.

As other competitors for global capital race along the highway of liberalization, Argentina risks slipping further behind, even if it just stands still.

As The Wall Street Journal's George Melloan detailed in this space on Tuesday, Egypt is just such a liberalizer. During a visit to our offices last week, Egyptian Prime Minister Ahmed Mohamed Nazif and his economic team said that reform is required because 3-4% gross domestic product growth is not sufficient to reduce poverty. Acknowledging the link between economic freedom and rapid growth and development, Egypt is doing what Mr. Kirchner rejects: moving to reduce the drag of big government on the economy.

Egyptian Finance Minister Youssef Boutros-Ghali could have been describing Argentina when he told us that under the traditional state system, "Government is a predator and the citizen is the prey. You pounce on him and you squeeze him all you can." Egypt wants to break with that tradition so as to attract capital and boost economic activity. Speaking like a Reagan supply-sider, Mr. Boutros-Ghali offered that any revenue loss under his tax plan to cut rates and provide an amnesty would be offset by higher growth and more taxpayers coming into the formal economy.

This sort of thing isn't rocket science. It's Reality 101 and it underscores not only the universality of economic law but also the global competition that Argentina faces. Granted, pro-market reforms would create an uproar among Mr. Kirchner's anti-market, anti-American constituency and he would have to exert some leadership. But he could tell the left that he is simply copying the economic policy of a Middle Eastern country with a socialist tradition. That ought to energize his base.
 
 

Egypt Is Beginning to Awake to Its Problems George Maloen
May 24, 2005; Page A13

Laura Bush this week is promoting women's rights in Egypt, a place that would benefit from improvement on that front and on civil rights in general. On the whole, the First Lady's Middle East mission has not been warmly embraced, even in Israel, where protestors demanded that the U.S. release Jonathan Pollard, an American Jew now serving a life sentence for spying for Israel.

But it comes with the territory, as the old saying goes, and Mrs. Bush deserves high marks for invading a tumultuous and dangerous region to promote her husband's central foreign-policy objective, the spread of political freedom.

Egypt is an excellent place for such missionary work. It has been a leading recipient of U.S. foreign aid since Jimmy Carter greased Egypt's 1978 Camp David accords with Israel by giving large dollops of American taxpayer cash to both countries. Cairo has collected $57 billion since then, and the U.S. still writes a $2 billion check each year. The fact that a dictator, President Hosni Mubarak, has been drawing this generous payoff for the last 24 years is something of an embarrassment to an administration preaching political freedom.

During most of that time, President Mubarak was no great shakes on economic policy either. Egypt has been slow to develop, with tourism and agriculture still accounting for nearly 80% of its GDP. Per capita GDP is only $4,200 a year and over 16% of its 77 million people have incomes below the poverty line. Egypt offers strong support for the modern theory, abhorrent to rich-country do-gooders, that foreign aid, whatever its benefits, often serves to keep bad governments in power.

But even in this, the most populous Arab state, there are winds of change. Last July, President Mubarak chose an Alexandria-born Ph.D. in computer engineering to head his National Democratic Party (NDP) government. For a change, the new prime minister, Ahmed Mohamed Nazif, had a positive economic agenda. He has slashed customs duties in half unilaterally without seeking reciprocity from trading partners. He cut the corporate tax rate to 20% from 42% with a comparable cut in the top personal rate. He has taken a knife to bureaucratic red tape and stepped up privatization of state enterprises.

Mr. Nazif visited President Bush last week to tell him about President Mubarak's recent much-ballyhooed initiative to allow other candidates to contest the presidential election next September. He also visited with editors of this newspaper to tell us that Egypt is now open for business. The first proposition, that Mr. Mubarak will get competition, is dubious because of remaining barriers to candidacies, but Mr. Bush decided to give the Egyptian dictator the benefit of the doubt. On the second proposition, economic reform, Mr. Nazif had an impressive story to tell at the Journal offices in New York. Clearly, he is doing what he can to create a better business climate in Egypt.

Government bureaucracy, long the bane of Third World entrepreneurs and increasingly a problem in the First World, has been attacked by the computer-scientist premier. "Past governments had added thousands of employees just to provide employment," he told us. "I ended that." There has been a sharp reduction in government employment, partly because of privatization.

Finance Minister Youssef Boutros-Ghali, nephew of the former U.N. secretary-general, added that a "predatory state," determined to squeeze everything possible out of the people, had been inherited from colonialism by Egypt. "We are changing that to a state that serves the people." Blaming a lot of bad things on colonialism is common practice in Europe's former possessions, but that can be excused from a proactive government that is trying to set things right.

One key measure of success in an assault on bureaucracy is how long it takes to cut through the red tape required for starting a business. The Nazif crew claims to have cut that time to a few days from something like five months. As a result, they claim, a total of 3,012 new companies were established between last July and February 2005, with total capitalization of $1.9 billion. That's double the amount of the like period of a year before.

During the last 10 months, the government has derived twice as much money from privatizations as it received in the four years preceding. Its 2005 program calls for putting 54 public-sector companies on the block, out of the 170 remaining.

The tax cuts initially enlarged the government's deficit, but independent estimates of economic growth are being revised upward because of the cuts in custom duties and taxes and the improved business climate. For fiscal year 2006, beginning in July, estimates are that real growth will exceed 5%, compared with some 4% in this fiscal year. The Egyptian pound and stock prices are showing the effects of this improved growth outlook and reduced inflationary pressures.

But of course, there is still the political question mark. President Mubarak has sought to justify his one-man rule by raising the specter of Islamic fundamentalism. It is not forgotten that Anwar Sadat, the man who made peace with Israel, was assassinated by Islamic fundamentalists. The Muslim Brotherhood, which advocates Islamic government and law, is banned from politics, although members as individuals are allowed to hold office.

Yet there are signs that the Bush administration is growing weary of this argument. With support and some pressure from Congress, it has begun funneling money into Egypt to finance groups working for open elections by training lawyers to represent candidates and the like. The State Department's Middle East Partnership Initiative is giving $1 million in grants to five such groups. Cairo's Ibn Khaldun Center, named after the great 14th century Arab philosopher of human advancement, is unloved by President Mubarak but was granted $400,000 for its efforts to hasten progress.

One suspects that Mr. Nazif, while upholding the line that Egypt must preserve its secular society against fundamentalism, has some sympathy for the democrats. In a speech at the World Economic Forum in Davos last winter, he said, "We need to increase the participation of society as a whole and in particular our younger generations in the management of our destiny." Well said.
 

Saving Africa
By Nima Sanandaji and Tomas Brandberg   Published    05/25/2005
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The political left has for decades had a monopoly on defining Africa's problems. The poverty and misery there are blamed on capitalism, multinational companies, lack of foreign aid and an uneven distribution of the world's resources.

Indeed there is a significant difference in living standard between Western countries and Africa. The total economy of the 48 countries in Sub-Saharan Africa is smaller than the combined economy of six American states (California, Florida, Illinois, New York, Pennsylvania, and Texas). However, this difference is not due to an uneven allocation of the world's resources, but because the production of goods and services is so much higher in industrialized countries. A common socialist myth is that the high American living standard would depend on exploitation of Africa. How could this be the case when only 0.4 percent of the US economy is based on trade with all African countries?

"It is not the culture that has prevented Africa from growing but the policies governments have inflicted on their people. With good policies, there is nothing in African culture to prevent these nations from joining in increasing numbers the economically advanced nations of the world."

- Gary Becker. Human Capital and Poverty, Religion and liberty 1998.

Africa's poverty is not due to exploitation by Nike, McDonalds and Microsoft, but rather because it is the continent where multinational companies are the least active and which is the least capitalist. Above all, the region south of Sahara has since its liberation in the 1960s and 70s been dominated by protectionism, extensive government interference and disregard of market mechanisms. Several countries, such as Somalia, Benin, Ethiopia, Angola and Mozambique, were classical Marxist-Leninist Communist states for many years. Others opted for the so called "African Socialism", the most typical example probably being Tanzania. Almost all states in the region resort to extensive tariffs and other restrictions on imports, which hurts trade with multinational companies as well as intraregional trade.

"By law, all Ethiopian land is owned by the state. Farmers are loath to invest in improving productivity when they have no title to the land they till. Nor can they use land as collateral to raise credit. And they are taxed so heavily that they rarely have any surplus cash to invest."

-The Economist, "People Aren't Cattle," July 17, 2004.

History has proven that foreign aid is not the solution to Africa's problems. Total overseas development assistance (ODE) that went to sub-Saharan Africa between 1984-2002 accounted for $319 billion. This corresponds to approximately 80 percent of the region's total GDP in 2002. Despite this relatively large development investment, 23 countries in the region experienced negative compound annual growth between 1980 and 2002, while only three achieved growth over 4 percent. During this period, GPD per capita in sub-Saharan Africa fell from $660 to $577 dollars (in constant terms). Foreign aid fosters dependence, corruption, plan economy and government waste

Africa's real problem is the lack of private investment. According to the OECD, private capital flows to developing countries between 1990-97 exceeded $600 billion. However, only $10 billion of this amount went to sub-Saharan Africa of which $9 billion went to South Africa.

Africa is poor because most countries in the region lack the fundamental elements of a capitalist system: property rights, free markets, free trade and the rule of law. Africans are like everybody else, and ideas that did not work in China, North Korea and the Soviet Union will not work in Africa either. The blame for the present situation in Africa does not lie with capitalists. It lies with corrupt politicians, who have implemented bad economic policies, together with leftist intellectuals who convinced African politicians to implement anti-capitalist economic policies. The west is also responsible, by enforcing trade barriers. It is ironic that anti-globalization movements are frequently opposed to abolishing tariffs and import quotas.

"All special advisers to underdeveloped countries who have taken the time and trouble to acquaint themselves with the problems, no matter who they are . . . all recommend central planning as a first condition of progress."

- Swedish socialist Gunnar Myrdal, winner of the Nobel prize in economics 1974.

Libertarian and conservative thinkers must focus more on the debate on Africa's problems and its future. The inhabitants of the world's poorest continent are the ones who most need economic and political freedom. In addition, many followers of the political left base their ideology on the idea that capitalism has impoverished Africa and that socialism is the solution to the continent's problems. If proven wrong they might be willing to reconsider their support for socialism.

Nima Sanandaji is a student of biotechnology at Chalmers University of Technology (located in Gothenburg, Sweden) and has been accepted at Cambridge for graduate studies in biochemistry. Tomas Brandberg is PhD student in biotechnology at Chalmers University of Technology.
 

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The Right to Work
May 12, 2005

A lot of people marvel that U.S. GDP per capita is about 30% higher than the West European average, but the main reason is surprisingly simple: Americans just work more. The U.S. labor-force participation rate is more than six percentage points higher and unemployment is about half the European level. And while German and French workers clock in about 1,400 hours per year, Americans work almost 1,800 hours.

The one major European economy that is similarly industrious is the U.K. But yesterday, the Socialist, Labor and Green members of the European Parliament decided they would no longer tolerate this aberration. They voted in favor of scrapping an opt-out clause that exempts the U.K. from an EU law limiting the average working week to 48 hours. More precisely, the clause allows British workers to opt out from this EU law -- if they so wish. No employer can force a worker to do overtime. And no country has to follow Britain's lead here.

While the opt-out clause preserves the British workers' right of contract, Europe's lawmakers want to take it away, claiming they know best what's in the interest of those workaholics across the channel. "The opt-out runs counter to the goals of worker health and safety," said Spanish Socialist Alejandro Cercas, conjuring up the image of exhausted, accident-prone workers.

But the U.K. doesn't really compare unfavorably in this respect. According to Eurostat, Britain recorded 85 fatal work accidents per 100,000 employees in 2002. That's only slightly worse than Germany's 82 but better than the Netherlands' 90 -- even though the Dutch work fewer than 1,400 hours per year, less than anyone else in the EU.

Far from showing any real concern for the health or family life of British workers, the Socialist lawmakers are engaged in the time-honored practice of raising their competitors' costs. In this case, the competitor is the U.K., whose more liberal employment policies make it an attractive destination for investment and jobs within the EU. This in turn puts pressure on Europe's more-socialist countries to reform or lose jobs. But the socialists have found a third way -- make the U.K. less competitive by making its labor market less flexible. Disappointingly, British Labour Party members of the European Parliament have gone along with this assault on British liberty.

Luckily, British Prime Minister Tony Blair is unlikely to follow their lead. Governments have the last word and Britain needs only a blocking minority in the EU council of ministers to preserve the opt-out. Some of the fast-growing new member states, where workers work on average 112 hours more per year than their West European colleagues, have already pledged Britain their support. Once again, enlargement turns out to be blessing for all of Europe.